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Houston Chronicle: The Subsidiary Excuse

November 04, 2006
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By GAP General Counsel Joanne Royce and National Employment Lawyers Association (NELA) Executive Director Terisa E. Chaw. This op-ed also appeared in the Baltimore Sun, Salt Lake Union Tribune, and the Canton Repository (OH).

 

When former Enron Chief Executive Jeffrey K. Skilling was sentenced last week to more than 24 years in prison for his role in the company's 2001 collapse, it was a reminder of how the Enron scandal forced changes in government's oversight of corporate America.

In the wake of that scandal, Congress strengthened securities laws in 2002 to protect investors and markets from future financial disasters. Unfortunately, powerful corporations are challenging these laws in bitter legal disputes across the country. One such battle threatens to disarm perhaps the most effective post-Enron legal remedy: the protection of corporate employees who identify suspected securities fraud within their corporations. This provision, as part of the Sarbanes-Oxley bill, was designed to avert economic disasters by shielding whistle-blowers of publicly traded companies from retaliation.

Corporations are capitalizing on minor ambiguities in the language of this whistle-blower statute to claim that only employees of parent corporations, not wholly-owned subsidiaries, are covered by these legal protections. Defense lawyers find support for this argument in "black letter" corporate law, which contends that parent companies are independent from subsidiaries and should thus not be held liable for subsidiary misconduct.

In truth, subsidiaries of publicly traded corporations are inextricably connected to the financial make-up of their parent companies. Unless these subsidiary employees are protected under Sarbanes-Oxley provisions, large-scale fraud might go unreported and undetected, resulting in significant harm to investors.

Consider John Ambrose's case. He worked for 15 years as a top salesman for US Foodservice, a wholly owned subsidiary of Royal Ahold, a large-scale supermarket operator whose holdings include the Giant chain. In 2003, Royal Ahold disclosed to the Securities and Exchange Commission that USF had artificially inflated revenues and supplied fraudulent financial information to the commission. Subsequently, Mr. Ambrose submitted testimony to the SEC in 2004, at its request, regarding USF's supposed fraudulent accounting practices and possible insider trading. Soon after, Mr. Ambrose was fired, and he filed for protection under Sarbanes-Oxley.

Subsidiaries of corporations often account for the lion's share of a corporation's gross profits and employ the most corporate personnel. Indeed, USF is an integral component of Ahold's business, representing nearly one-third of its net sales in 2004.

A few judges, including the one who ruled on Mr. Ambrose's case, have unfortunately agreed with corporate lawyers who deny that Congress intended to protect subsidiary employees. This is true even where those employees uncover fraud by the parent company. The case is now on appeal before the Administrative Review Board, a rather obscure three-judge panel within the Department of Labor. This decision will be critical, and its ramifications huge, as once the review board rules, the federal circuit courts throughout the nation must extend a measure of deference to the ruling.

There is more at stake here than protecting investors from financial fraud. Consider what this loophole would mean for one of the nation's largest holding companies, Berkshire Hathaway. This parent company has close to 200,000 workers at subsidiaries across multiple industries, including Fruit of the Loom, Borsheim's Fine Jewelry and International Dairy Queen Inc. This last corporation was a publicly traded company before being bought out by its parent in the late 1990s. Without Sarbanes-Oxley whistle-blower protections extending to subsidiaries, hypothetically, a Dairy Queen employee who wished to report tainted food entering the nation's markets would not be entitled to any protection and could face retaliation and risk professional suicide.

Common sense dictates that eliminating employees of subsidiaries from coverage under the statute would eviscerate the whistle-blower statute and thoroughly undermine the law's stated goals. During congressional debate over Sarbanes-Oxley, Sen. Patrick J. Leahy, a Vermont Democrat, noted: "When sophisticated corporations set up complex fraud schemes, corporate insiders are often the only ones who can disclose what happened and why."

Corporate fraud thrives on secrecy. Sarbanes-Oxley can only combat that secrecy if companies cannot intimidate their workers into silence. It is the natural course of capitalism for smaller companies to keep being acquired by larger ones - which is why Congress surely intended for Sarbanes-Oxley to cover subsidiaries, lest more workers lose their protection, and threats to public welfare not be exposed.

Failure to protect employees of subsidiaries will disarm one of the most potent deterrents to corporate corruption: the informed insider willing to blow the whistle. Corporations all over the country are hoping this failure becomes a permanent reality. If they win, American investors will lose.

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