Prohibition on Loans to Directors and Officers
Whistleblower Protections
The Sarbanes-Oxley Act, signed into law by President Bush on July 30 2002, makes significant changes to the laws governing public companies. In this post-Enron world of heightened scrutiny, the majority of the act's provisions address issues of corporate governance. However, the new law does contain several key provisions that will affect public companies' relationships with their employees and potentially lead to a new category of litigation between employer and employee.
Prohibition on Loans to Directors and Officers
Section 402 of the act provides:
"It shall be unlawful for any [public company], directly or indirectly, including through any subsidiary, to extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof)."
With limited exceptions, this provision bans all sorts of credit arrangements that have sometimes been part of executive compensation packages, including loans to pay taxes or to finance the purchase of homes or personal items. Indirect arrangements having the same purpose or effect (ie, company guarantee of a personal loan to a director or executive officer, or a loan to a family member of a director or executive officer) are similarly barred.
Other commonplace practices are also banned. For example, 'cashless' exercise of stock options - under which the issuer/sponsor arranges for a brokerage firm to extend credit to the participant to cover the exercise price, with the brokerage firm being repaid almost immediately with the proceeds of the sale of some of the newly acquired stock - could well fall foul of the new law. Loans to participants under 401(k) plans, split-dollar insurance arrangements, loans from corporate-sponsored credit unions and the use of company credit cards for personal expenses (even though subsequently paid by the executive) likewise are all arguably impermissible under the act.
Pre-existing loan arrangements are not rendered illegal by the act and need not be immediately unwound. Nonetheless, companies should consider with care whether, under the particular circumstances of the loan arrangement, a post-July 30 advance under a pre-existing loan or a modification of a pre-existing loan might be construed as violative of the act.
The act's provision barring credit arrangements is far-reaching and broad, and there is little legislative history available to guide employers in determining the reach of its prohibition. Prudence thus counsels that employers act with caution in assessing the risk that arrangements with directors and executive officers fall within the scope of prohibited activity.
Section 806 of the act provides whistleblower protection to employees of public companies who disclose information concerning fraudulent activities within their companies. The statutory language extends to officers, employees, contractors, subcontractors and agents, and appears to contemplate individual liability for any person guilty of taking an adverse employment action or otherwise discriminating against any individual for having engaged in a protected activity.
The types of activity protected under the act include (i) disclosing information or otherwise assisting federal regulatory agencies, law enforcement agencies or Congress, and (ii) assisting in a proceeding alleging a violation of Securities Exchange Commission rules or regulations, or another federal law relating to fraud against shareholders.
The act specifically extends protection to employees who complain to a supervisor or other employees "who have the authority to investigate, discover or terminate other employees for misconduct".
The act establishes a mandatory administrative procedure to be followed by a whistleblower who claims retaliation based upon protected conduct. The employee must file a complaint with the Department of Labour within 90 days of the alleged violation. The secretary of labour is not permitted to investigate a complaint unless the employee makes a prima facie showing that protected conduct was a contributing factor in the adverse employment action taken by the employer. If the employee makes such a showing, the investigation nonetheless may not proceed if the employer demonstrates through clear and convincing evidence that it would have taken the adverse employment action in the absence of the protected conduct. If the Department of Labour does not resolve the complaint within 180 days, the employee may commence an action in federal court.
The remedies available to a successful litigant include reinstatement, back pay, interest, compensatory damages and litigation costs (including attorneys fees). In addition, the act provides for criminal penalties against employers and their agents who intentionally retaliate against any person for providing a law enforcement officer with truthful information relating to the commission or possible commission of any federal offence.
Employers must take great care in considering the termination, suspension, demotion or reassignment of any employee who complains about securities fraud. Human resource professionals and supervisors should be trained to identify and report activities that are protected by the act, and to ensure that no retaliation, discrimination or adverse employment action is prompted by such activities.
For further information on this topic please contact Kevin B Leblang or Robert N Holtzman at Kramer Levin Naftalis & Frankel LLP by telephone (+1 212 715 9100) or by fax (+1 212 715 8000) or by email ([email protected] or [email protected]).