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When to Blow the Whistle
(With Respect to a Private Organization)
John P. Beavers
Reprinted from Acredula -- Spring 2007
The following is from a luncheon presentation by John Beavers at the annual Private Companies Conference of the Ohio
Society of CPAs on December 7, 2006.
As a result of the Sarbanes-Oxley Act of 2002,
which prohibits retaliation against those who report
irregularities within an organization, there’s been
plenty of encouragement to “blow the whistle.”
There has been little guidance, however, as to when
it’s appropriate to do so, especially with respect to
tax-exempt organizations and private companies.
The legal definition of “whistle-blowing” means
to report an organization irregularity either to
someone internally within the organization, which
is referred to as “reporting up,” or
to a regulatory or enforcement official
or agency, which is referred
to as “reporting out.” In many
states, including Ohio, statutes
that protect whistle-blowers require
the whistle-blower to “report
up” to a superior before he or she
is entitled to protection for “reporting
out” to law enforcement
or a prosecuting authority.
This article will offer guidance on when a person
may be legally required to blow the whistle, with
respect to an organization. However, the legal
requirements determine only minimum standards,
so this article will also provide the best practices
for the organization to deal with whistle-blowing,
and for the individuals who have to decide whether
and how to blow the whistle.
General Rule
Generally, there is not legal liability if a person
fails to speak, report, or “blow the whistle” unless
there is a legal duty to speak. So, when do you
have a legal duty to speak?
When Do You Have a Legal
Duty to Speak?
When you have knowledge of a felony, it is a crime
under Federal law for a person to not report the
felony to a U.S. judge or civil or military authority
as soon as possible. Similarly, it is a crime in Ohio
law, and that of many other states, to knowingly
fail to report such information to law enforcement
authorities. These instances are generally known
as the “misprision” of a felony statute.
When a person makes a written or oral statement
under oath (or, for Federal law, under oath or penalty
of perjury), it is a crime to make a false material
statement that is knowingly not true. This includes
not only when you are under oath for purposes of a
court, legislative or administrative matter, but also
during any deposition and many examinations by
investigation or law enforcement authorities. For
Federal law, this includes many filings, such as
tax returns that are made under penalty of perjury.
Therefore, you have a duty to speak when you have
knowledge of a felony or you are under oath or
penalty of perjury.
Absent knowledge of a felony, being under oath or
penalty of perjury, or having a legal duty to speak
typically depends upon your relationship to the
organization and whether the relationship creates
a fiduciary duty. Generally, being in any of the
following four relationships results in fiduciary
duties:
Director or member of the governing board, you have a duty to speak when an ordinarily
prudent person in a like position and under
similar circumstances would speak.
Officer, you have a duty to speak when
an ordinarily prudent person in a
like position and under similar circumstances would speak.
In an expert or professional relationship, such as a lawyer, accountant, auditor, tax advisor,
investment banker, etc., you have a duty
to speak when an ordinarily prudent expert in
your profession under similar circumstances
would speak. Beginning February 1, 2007, a
lawyer for an organization should report up to
the highest authority of the organization when
the lawyer knows, or should know, that an action
or refusal to act, (1) violates a legal obligation to
the organization, or (2) is a violation of law that
reasonably might be imputed to the organization
and is likely to result in substantial injury to the
organization.
ERISA fiduciary, you have the duty to act for
the exclusive purpose of providing benefits to
participants and their beneficiaries with the care,
skill, prudence and diligence under the circumstances
then prevailing that a prudent person
acting in a like capacity and familiar with such matters.
In addition, fiduciary duties can be created by
contract, including both the expressed terms
of an employment agreement as well as those
implied, such as impliedly agreeing to abide by
an organization’s employment policies or its
governing documents.
Ohio for-profit corporation law was amended in
July 2006 to provide that, absent an agreement to
the contrary, employees or vendors do not have
fiduciary duties to an organization or its shareholders
or creditors.
In summary, absent knowledge of a felony or being
under oath or penalty of perjury, you do not have
to speak or blow the whistle on your organization
unless you are:
A director or officer of the organization;
In an expert or professional relationship with the organization, such as a
lawyer, accountant, auditor, tax advisor,
investment banker, etc.; or
ERISA fiduciary.
What is Applicable in Sarbanes-Oxley (“SOX”)?
Only three provisions of SOX are applicable to constituents of private
companies. No one may:
Corruptly alter, destroy any record, document or other object, or conceal, or
attempt to do so, in an official proceeding, or otherwise obstruct, influence,
or impede the proceeding;
Knowingly, with intent to retaliate, take any action harmful to any person for
providing to a law enforcement officer any truthful information relating to the
commission or possible commission of any Federal offense; and
Knowingly alter, destroy, mutilate, conceal, cover up, falsify, or make a
false
entry in any record, document, or tangible object with the intent to impede,
obstruct, or influence any federal investigation or bankruptcy proceeding.
As a result of SOX, the following are the key areas for detection and addressing
of corporate fraud and abuse:
Violations of law or breaches of fiduciary duty
Misstatements in financial statements
Fraud or deficiencies in internal controls.
Although state law has always recognized that the highest authority of an
organization is its governing board, SOX generally focuses on directors or
board members who are independent of the organization as the highest authority.
SOX also created new reporting responsibilities for the chief executive
officer, chief financial officer, and chief legal officer of any organization
that is a public company.
What Are the Trends?
In the four-year period before the 2006 elections, in
which Washington, D.C., and the State of Ohio were
considered “business-friendly,” there were
more:
Official proceedings investigating corporate
fraud and abuse
Self investigations internally by companies
Difficulty negotiating settlements
Prosecution of directors, officers, professionals
or ERISA fiduciaries
Disgorgement of profits or gain
Barring from serving as director, officer or
fiduciary of others.
Many of us expect an exponential increase in
investigations and prosecutions because of bi-partisanship
in Washington, D.C., and Ohio resulting
from the election, especially as the 2008 elections
approach.
What Are Some Best Practices for Consideration?
Legal duties, including the legal duties to speak,
set only minimum standards for conduct. Better
practices than those minimum standards should be
considered by both the organization as well as any
whistle-blower.
Considerations for the Organization
The organization should:
Facilitate “reporting up” within
the organization. Irregularities
can be more quickly and efficiently
detected and addressed
within the organization than by
government authorities.
Permit and facilitate anonymous
reporting, but encourage attribution.
A report without knowing
who is reporting it does not
allow
the recipient to evaluate the
credibility of the source or of the
report, both of which are important
evaluations.
Self-police by testing for compliance.
Sensibly delineate responsibility within the
organization for investigating and addressing
irregularities. For example, the chief financial
officer may be designated to receive reports of
irregularities that involve financial statements,
internal controls, accounting policies and the
auditing or review process. The chief legal officer
may be designated to receive reports that
involve violations of law or breaches of fiduciary
duty, and the head of HR may be designated to
receive irregularities that involve employment
matters. However, this designation should be
consistent with the culture of the organization.
Designate alternative channels for reporting
irregularities. An alternative channel or person
should be designated for each type of reporting.
Again, more than the main channel should be
consistent with the culture of the organization.
In each case, it may be the CEO, depending upon
the organization’s culture. In other organizations,
it may be the chief legal officer.
Involve legal counsel sooner than later for (i)
protection of information and (ii) advice as to
what constitutes a violation of law or breach of
fiduciary duty, as to credibility of the evidence
of such violations or breaches, and as to the
materiality of the violations or breaches.
Quickly and thoroughly investigate credibility
of evidence and materiality of any irregularity.
If a problem is found, remediate quickly with
no tolerance for violation of laws or breach of
fiduciary duties.
Maintain a written record of what was reported
and to whom, how it was investigated, what was
found and how it was resolved.
Self-report any violation of law to applicable
government agencies.
Cooperate with any applicable government
agency.
Provide independent counsel, paid by the organization,
for any material witness. It is important
that material witnesses are informed and remain
comfortable with what they may be asked
to
do.
Considerations for the Whistle-Blower
The whistle-blower should consider the following:
If you are involved as more than an observer,
immediately seek independent legal advice.
Remember, courts and government will view
self-reporting and cooperation favorably.
Report up before reporting out because courts
and government agencies encourage internal
investigations and remediation by companies.
Review Ohio’s whistle-blower statute (ORC
§4113.52) because it generally requires reporting
up in order to be protected for reporting
out.
When considering whether to report up, determine
whom you are required to report, and
in the case of doubt, report to (or copy) the
organization’s legal counsel because an attorney
for an organization has an obligation to report
such matters up to the organization’s highest
authority. Remember, the organization’s counsel,
whether in-house or retained, represents the
organization and not you.
If you report up, disclose all that you know. Assume
that the information you disclose belongs
to the organization, which may or may not report
it to the government without consulting you.
Also, assume the organization
will ask you to maintain confidentiality.
Document your report in writing
and with attribution.
Ask if the organization will provide,
and/or pay for, independent
legal counsel for you.
Finally, remember that the standard
by which you will be judged is what an ordinarily
prudent person in a like position would do under
similar circumstances.
