The Workplace Law Landscape After Enron
Enron. Tyco. WorldCom. Qwest. These words, which once evoked the dizzying heights of the go-go Nineties, now stand for morality tales of corporate abuses, excess, and disintegration - and strike fear into the hearts of company executives, managers, and employees alike. Corporate counsel, too.
From a legal perspective, the downfall of these companies has had major repercussions. First, the infamous accounting abuses and excessive executive compensation practices prompted wide-ranging new legislation, in the form of the Sarbanes-Oxley Act, setting forth significant new rules for corporate governance. Second, the Department of Labor and the courts are now enforcing more strictly ERISA provisions concerning the creation and administration of employee stock ownership plans ("ESOPs"). Third, well-chronicled improprieties by high- and mid-level corporate employees have led companies to implement or revisit written employment policies and covenants designed to prevent business and financial employee misconduct, such as policies regulating business ethics, insider trading, and confidentiality. To avoid becoming another corporate casualty, employers must grapple with the new laws, attend to the old ones, and adopt and maintain lawful and appropriate policies in a post-Enron world.
The Sarbanes-Oxley Act of 2002 (the "Act") introduced sweeping reforms to corporate governance. The employment-related aspects of the Act mainly concern whistleblower protections, preservation of records and obstruction of justice, the prohibition of certain perquisites which could constitute personal loans to company officers and directors, and ERISA plan notice requirements of "blackout" periods, during which plan participants are prohibited from selling company stock.
Section 806 of the Act creates federal "whistleblower" protection for employees of public companies who act lawfully to disclose information about fraudulent activities within their company. This section applies where the employee reasonably believes that there is or has been a violation of federal securities law, the rules of the SEC or "any provision of federal law relating to fraud against shareholders" occurring within the company.
The Act protects the employee in complaining to assist criminal investigators, federal regulators, Congress, parties in a judicial proceeding or any person within the company with the authority to "investigate, discover or terminate misconduct." The violations at issue may include those of company officers and employees, as well as contractors, subcontractors, or agents.
In the event of the company's retaliation against an employee because of such a complaint, the Act permits the employee to file a complaint with the Department of Labor ("DOL") within 90 days of the alleged retaliation. If the whistleblower presents evidence that a protected complaint was "a contributing factor" in the adverse employment action, the DOL is to hold a hearing, at which the employer must prove by clear and convincing evidence that it would have taken the same adverse employment action even in the absence of the whistleblower's protected activity.
If the DOL does not resolve the matter within 180 days, the claimant is entitled to sue the employer in federal court (absent his or her own bad faith delay in cooperating with the DOL). A prevailing whistleblower may be entitled to reinstatement, back pay with interest and compensatory damages to make the claimant whole, including reasonable attorneys' fees and costs. The Act does not provide for either punitive damages or a jury trial, but it does not preclude the claimant from raising state law claims for which, depending on state law, emotional distress and punitive damages against the employer may be available remedies.
Beyond these civil remedies, Section 1107 of the Act further provides for criminal penalties in the event of unlawful retaliation. It provides that whoever knowingly, with the intent to retaliate, takes any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any federal offense, will be subject to up to 10 years in prison.
Finally, the Act requires the implementation of reporting procedures for employees of public companies. It mandates that company audit committees provide procedures for the confidential, anonymous submission of employees' concerns about accounting or auditing matters. Although employers might be able to use existing "hotlines" or other modes of internal communications for this purpose, the final decision rests with the audit committee, in which the Act vests substantial responsibility and independence.
Preservation Of Records And Obstruction Of Justice
Under the Act, it is a felony to knowingly alter, destroy, mutilate, conceal, cover up, falsify or create a false entry in "any record, document or tangible object" to "impede, obstruct or influence" any existing or contemplated federal investigation or the "investigation of any matter within the jurisdiction of any department or agency of the United States or any bankruptcy case."
This provision closes a loophole in the pre-existing law, 18 U.S.C § 1510, by making it a criminal offense to act alone in destroying evidence (as distinct from persuading others to do so), even when the destruction of evidence occurs prior to the issuance of a grand jury subpoena. The punishment is a fine and/or 20 years imprisonment.
Given this broad statutory language, the obstruction of justice provisions of the Act do not appear to be restricted to accounting or auditing matters, but likely would encompass any government investigations of employment matters, such as wage-hour, OSHA and EEOC investigations.
Prohibition Of Practices Constituting Personal Loans To Executive Officers And Directors
Section 502 of the Act prohibits public companies from directly or indirectly extending or maintaining credit, arranging for the extension of credit or renewing an extension of credit in the form of a personal loan to or for an executive officer or director of the company. Violation of the prohibition can result in criminal penalties.
Although this section clearly was aimed at ending the infamous practices (at Enron and elsewhere) of providing loans to officers and directors for their purchase of homes, company stock and other goodies, the broad language of the statute could well prohibit other much more common and less luxurious perquisites such as travel and expense cash advances, advances for relocation expenses, cashless option exercises and even company credit card accounts. What this all means is that the prudent public company might want counsel to re-evaluate a host of routine and seemingly benign business practices in light of the perhaps unintentionally broad sweep of the Act.
ERISA Plan Notice Of "Blackout" Periods Prohibiting The Sale Of Company Stock By Plan Participants
Finally, in an obvious reaction to the Enron debacle, where Enron pension plan participants were barred from selling company stock in their plans while the value of their assets dropped dramatically, the Act introduces a heightened notice requirement of "blackout" periods, during which plan participants are prohibited from selling company stock. Under the new requirement, ERISA plans must provide 30 days' advance notice of blackout periods when such restrictions would affect at least one-half of a public company's plan participants for more than three consecutive business days. The Act further imposes a ban on the purchase or sale of company stock by officers, directors, and other insiders during such blackout periods.
Needless to say, public companies must be sure to comply with all of the new rules imposed by the Act. Privately held companies must observe the new preservation of records requirements and, if they have ERISA plans, the notice provisions in the event of the imposition of blackout periods.
Compliance With ERISA In The Creation And Administration Of Employee Stock Ownership Plans
In addition to prompting the passage of the Sarbanes-Oxley Act, the recent spate of corporate accounting and stock scandals has led the DOL and courts to more strictly enforce the provisions of the Employee Retirement Income and Security Act of 1974 ("ERISA"), 29 U.S.C. §§ 1001-1461, governing the creation and administration of Employee Stock Ownership Plans ("ESOPs"). This heightened scrutiny should, in turn, lead ESOP fiduciaries to thoroughly understand and discharge the duties they owe to employees.
ESOPs are plans authorized under ERISA that permit substantially all of a plan's assets to be invested in employer stock for eventual distribution to employee participants upon retirement. ERISA generally prohibits the practice of purchasing company stock by an employee benefit plan because inherent in such transactions is the risk that plan trustees will engage in self-dealing and have conflict of interests to the detriment of plan participants; but an exception to this prohibition permits the creation of ESOPs when the purchase of employer stock is for "adequate consideration." 29 U.S.C. § 1108(e). A central duty of ESOP trustees, therefore, is to ensure that the ESOP purchases of employer stock are for adequate consideration.
The DOL has taken the position in recent cases involving ESOP transactions that ESOP trustees breached their fiduciary duties in violation of ERISA where purchases of employer stock were for greater than fair market value. This position is notable because in common parlance "adequate consideration" is defined as "fair compensation" or "sufficient recompense for work done." Random House Webster's Dictionary 434 (2d ed. 2001). The DOL's position thus suggests something beyond common notions of "adequate consideration" and reflects an aggressive enforcement of the statute. Moreover, the U.S. Court of Appeals for the Sixth Circuit recently ruled that the payment of fair market value for employer stock is but one of two essential elements comprising "adequate consideration," the second being a demonstration by the ESOP trustees that they made a "good faith determination" of the price of employer stock before purchasing it. Chao v. Hall Holding Co., 285 F.3d 415, 436 (6th Cir. 2002). (This requirement of a good faith determination has likewise been imposed by the Second, Third, Fifth, Seventh, and Ninth Circuits.) The Chao court also specifically held that an ESOP trustee could not necessarily rely on the expert valuation of an independent appraiser where the appraiser made errors or was not provided all necessary information, and that there is no "subjective intent" requirement for proving an ESOP trustee breached its fiduciary duties in connection with overpaying for employer stock. Indeed, the Sixth Circuit and many courts have now ruled that ERISA violations relating to the purchase of stock for ESOPs are per se violations; even an unintentional purchase of stock for greater than market value by ESOP trustees could result in liability.
The enhanced scrutiny currently being visited upon ESOPs by the courts and the DOL should lead ESOP trustees to take steps to ensure full compliance with ERISA when they purchase employer stock. At a minimum, ESOP trustees, in consultation with counsel, should: (1) participate in the negotiation of the stock purchase price and ensure that it is not greater than fair market value; (2) utilize an independent appraiser with sound qualifications and provide the appraiser with complete and accurate information; (3) avoid even the appearance of self-dealing or conflicts of interest; and, most importantly (4) independently determine that the purchase of employer stock will benefit the long-term interests of the plan participants.
Implementation And Maintenance Of Appropriate Company Policies And Agreements Relating To The Conduct Of Employees In Business And Financial Matters
Even aside from ensuring compliance with new and pre-existing law, employers can take steps to protect their companies from scandal and liability arising from the business and financial misconduct of their employees by adopting effective company policies and agreements addressing such concerns as business ethics, insider trading, and confidentiality. Even employers who already have such written policies in place should revisit them, with the assistance of counsel, to ensure that they provide the necessary and appropriate protection available under the law against deceptive and improper acts by employees. And while published written policies are a good start, it is generally a better idea to create written agreements, requiring the individual employee's signature, which become contractually binding. Such agreements can both deter and provide a measure of legal protection against employee misconduct which, as we have so clearly seen in recent months, can jeopardize a company's very existence.