Corporate & Securities Law

A former general counsel did not suffer unlawful retaliation under the Sarbanes-Oxley Act, concluded a federal district court (DC Md, Harkness v. C-Bass Diamond, LLC, Civil Action No. CCB-08-231.) Cynthia L. Harkness could not recover because her reports concerning alleged improper conduct by the company and its CEO were not protected activity under the statute's whistleblower provision.

Harkness was general counsel of Fieldstone Investment Corp., a company that was in the process of going public (Fieldstone subsequently merged into the named defendant). Fieldstone had not yet effectively registered with the SEC at the time of the events that formed the basis of her first allegation, however. She learned that the company's CEO, Michael J. Sonnenfeld, communicated non-public information about a possible earnings restatement to an outside investor. She interviewed the sources of this information and the CEO, and reported to the audit committee chairman what she believed might be a violation of Regulation FD.

After these events, the relationship between Sonnenfeld and Harkness deteriorated. Harkness claimed that Sonnenfeld began to criticize her legal advice and treat her in a generally hostile manner. The company also excluded her from management meetings and actions, and reduced her responsibilities prior to terminating her employment.

Judge Catherine Blake initially found that her reports concerning the alleged Regulation FD violation were not supported by an objectively reasonable belief that the conduct constituted a violation of the relevant law. The applicability of the regulation was in doubt because Fieldstone was not a public company at the time of the disclosures. The general counsel did not investigate or research the applicability of Regulation FD before contacting the audit committee chairman. While it is not necessary to have conclusive proof of the violation when reported, her belief could not be reasonable as a matter of law in light of "the undisputed fact that Ms. Harkness had the resources available to her to help clarify this threshold question, but failed to utilize them."

Her reports to the audit committee that she was unable to verify that the company was complying with its legal obligations because she was excluded from meetings and events was also not protected conduct. Judge Blake agreed with Harkness that a company "which restricts its flow of pertinent information to its general counsel is at a greater risk of flouting its legal obligations," but she concluded that "such an enhanced risk does not in and of itself constitute a violation of federal securities law." Because she could identify no specific illegal conduct, her claims failed.

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Full post as published by Jim Hamilton's World of Securities Regulation on March 17, 2010 (boomark / email).