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First Circuit Establishes Standards For Private SOX Action

    Client Alerts
  • February 20, 2009

Passed in the wake of the Enron collapse, the Sarbanes-Oxley Act (SOX) allows employees of publicly-traded companies to sue their employers for retaliation if they believe they were fired, demoted, etc. for complaining about certain financial or accounting improprieties.  In Day v. Staples, Inc., an employee alleged that he was terminated in retaliation for complaining about Staples' accounting practices relating to customer returns.  He sued under SOX, claiming that the termination was in retaliation for his protected activity.

Staples sought dismissal of the claim, stating that the plaintiff never reasonably believed that his complaints involved violation of securities laws, or shareholder fraud.  The First Circuit noted that SOX is silent on the standard for determining the employee's reasonable belief.  In affirming dismissal of the claim, the First Circuit adopted an objective belief standard rather than the subjective test proposed by the plaintiff.  The court concluded that the plaintiff's complaints must relate in some demonstrable way to the particular securities law issues listed under SOX.

In this case, no reasonable person could conclude that the plaintiff's claims related to securities fraud.  He complained about an internal tracking system never reported to shareholders.  An inefficient or unfair tracking system does not raise the possibility of securities or shareholder fraud necessary to maintain an action under SOX.  In addition, mere accounting irregularities absent some fraudulent intent do not constitute the basis for a SOX action.  Finally, Day could never show that the issues he complained of presented any material risk of harm to shareholders.

If followed by other federal courts, this decision establishes a tough standard for plaintiffs to meet in SOX actions.  The plaintiff will have to show that the alleged corporate misconduct would have led to direct and material fraud against its shareholders, or at least a clear violation of securities laws.  His subjective belief that the company's actions met this test will not be enough to survive summary judgment.