Mutual fund companies have another reason to review and strengthen their compliance programs following a decision by the Supreme Court, according to experts.
On Tuesday, the court ruled, 6-3, that employees of mutual fund service providers are afforded federal whistle-blower protections under the Sarbanes-Oxley Act. Approved by Congress in 2002 following the collapse of Enron Corp. and WorldCom, the law is designed to combat corporate malfeasance at public companies.
“For the first time, employees at brokerage houses and investment advisory firms have general whistle-blower protection when they disclose fraud in the workplace,” said R. Scott Oswald, managing principal of The Employment Law Group.
The case centered on two former employees of
Fidelity Investments who claimed that they were fired for reporting fraud related to the mutual funds managed by Fidelity.
Fidelity asserted that their claims weren't allowed under Sarbanes-Oxley because they weren't employees of the mutual funds themselves. A district court denied Fidelity's motion to dismiss the case, while the 1st U.S. Circuit Court of Appeals upheld Fidelity's position.
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The Supreme Court overruled the 1st Circuit and remanded the case.
Writing for the majority, Supreme Court Justice Ruth Bader Ginsburg dismissed Fidelity's argument that the employees didn't work for the mutual funds.
“The mutual funds themselves are public companies that have no employees,”
she wrote. “Hence, if the whistle is to be blown on fraud detrimental to mutual fund investors, the whistle-blowing employee must be on another company's payroll, most likely the payroll of the mutual fund's investment adviser or manager.”
The decision will lead to a spike in whistle-blower claims, according to H. David Kotz, director of the Berkeley Research Group and a former Securities and Exchange Commission inspector general.
“The mutual funds, which previously didn't have to worry as much about whistle-blowers, now have to make sure they have plans put in place to deal with potential whistle-blowers who come forward and claim protection under SOX,” he said.
Mutual funds should heed the court decision, according to Todd Cipperman, managing principal at Cipperman Compliance Services.
“The lesson for fund firms is implement a quality compliance program, then you won't have the fraud that gives rise to whistle-blower concerns,” he said. “It's preventive maintenance.”
Mr. Cipperman doubts, though, that the ruling will create a wave of whistle-blower claims.
He pointed to the so-far modest results of the SEC whistle-blower program, which was established by the Dodd-Frank financial reform law.
Since the initiative was established in August 2011, the SEC has received 6,573 tips. The SEC provided $14 million in awards in fiscal 2013.
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“There has not been an avalanche of cases,” Mr. Cipperman said.
Even before its ramifications are known, the Supreme Court ruling will likely motivate companies to follow the law.
“It's going to reinvigorate the compliance function at companies that had been following their compliance procedures in the breach,” Mr. Oswald said.
A spokesman for Fidelity said that no court has made a determination regarding the merits of the claims against the firm.
“The allegations were unfounded when they were made, and they continue to be unfounded today,” Vincent G. Loporchio, Fidelity senior vice president, wrote in an email. He said that Fidelity offers employees a number of ways to report problems, including a confidential phone line.
“Fidelity encourages employees to make use of these channels through frequent and consistent communication from the top of our company,” Mr. Loporchio wrote.
