Backlash!

By many accounts, David Welch is a principled, God-fearing man who’s driven to do what’s right. That’s not exactly the view of his former employer, Cardinal Bankshares Corp. in tiny Floyd,Virginia.

As the company’s chief financial officer in 2002, Welch threatened to not sign off on then-new Sarbanes-Oxley financial certifications, allegedly because of concerns about accounting irregularities. Things got testy, and when Welch refused to meet the board’s investigators without his lawyer present, he was fired. Welch promptly challenged his removal, becoming one of the first employees in the nation to seek whistleblower protection under SOX.

Four years later, after numerous hearings and appeals, Welch’s case remains unresolved. A Labor Department administrative law judge, or ALJ, has twice ordered that Welch be given back his $60,000-a-year jobu00e2u20ac”with back pay, lawyer’s fees, and court costs. Cardinal, however, has appealed each timeu00e2u20ac”the most recent one is pendingu00e2u20ac”and has steadfastly refused to rehire Welch, at least until the process plays out.”I don’t think the board can trust that individual to provide them with the information they need to make decisions,” says R. Leon Moore, $191 million Cardinal’s chairman and CEO.

Welch has in turn fought to get his job back while the appeal is in progress, as the ALJ ordered.”David genuinely believed that Sarbanes-Oxley would protect him, and he’s run into a situation where the bank finds it impossible to admit it did anything wrong,” says his attorney, Bruce Shine of Shine & Mason in Kingsport, Tennessee. “He wants his name cleared.”

In October, a U.S. District Court judge ruled that Cardinal didn’t have to put Welch, 56, back on the payroll until a final decision is reached on Cardinal’s appeal.

A tangled web

It’s merely the latest twist in what has emerged as a closely watched test case of Sarbanes-Oxley’s whistleblower provisions. Section 806 of the law encourages employees to come forward with allegations of financial wrongdoing. If a worker is fired and can demonstrate it was due to raising questions about a potential securities law violation or federal fraud, the law requires that the employee be rehired.

“What sets Sarbanes-Oxley apart from other laws is a very strong preference for reinstating the employee as soon as possible,” says Daniel Westman, a partner with Morrison & Foerster and lead author of the 2004 book, Whistleblowing: The Law of Retaliatory Discharge. The reasons: to “identify additional violations and so co-workers aren’t chilled from raising similar issues,” he explains.

Since SOX became law in July 2002, roughly 200 people a year have filed complaints, claiming they were fired for exposing financial shenanigans. Most such complaints have been dismissed, and many experts criticize the law as too vague. Even so, about one-third of all cases filed thus far have been against financial institutions, according to Labor Department statistics.

In one notable case, Theresa Hagman, a former vice president with Seattle-based Washington Mutual, claimed to have been fired after complaining about improperly funded and underwritten mortgage loans. The Labor Department ordered that she be reinstated, but Hagman “feels that it isn’t possible or practical for her to return to work there because of the hostile environment,” says her attorney,Marc Susswein, a partner with Liddle & Robinson in New York. Instead, she now works for another institution and is seeking “front pay” from Wamu to cover the gap between her present salary and what she would have made in her old job.

Wamu officials have said they investigated Hagman’s charges, and found them to be without merit.

In theory, board members could be held liable if a company is found to have violated the law and lacked appropriate policies.”Even if there’s no substance to the charge, the fact that someone files a SOX whistleblower claim can drive down the stock price” and leave directors vulnerable to a securities class-action suit, says Jill Kirila, an employment attorney with Squire, Sanders & Dempsey in Columbus, Ohio. “So there’s definitely an incentive to handle these kinds of situations correctly.”

Responding to the whistle

What’s a smart board to do? Susswein says that as shareholder fiduciaries, directors must establish policies that “create an environment where people feel they can bring problems forward.” The law requires companies to establish a “hotline”u00e2u20ac”usually manned by an independent, outside partyu00e2u20ac”to field anonymous calls from employees with alleged violations to report. Prompt investigation of charges by an independent party also is mandated. “Ideally, you want to correct this kind of thing early, before it becomes a big, public deal,” Kirila says. “Once a complaint is filed, it’s out in the open.”

Boards also should be ready to rein in management. No executive likes to be accused of defrauding shareholders, Westman says, and it’s easy for a CEO to “react too quickly and terminate the employee without considering other options.” If faced with whistleblower allegations,Westman says board members should intervene and “strongly recommend” that the employee be offered a paid leave of absence while the charges are investigated. Since the person still has a job, a termination complaint can’t be filed. “When the investigation is complete, then you can deal with the situation.”

A difficult case

On the surface, the Cardinal-Welch saga looks to be just the kind of case Sarbanes-Oxley was meant to address. The son of a Baptist minister,Welch was hired as CFO in 2000, after 18 months as a part-time auditor. Shine says Welch initially had a good relationship with the board, and Moore doesn’t dispute it.”He was a likable individual,” he says.

That changed in the summer of 2001, when Welch questioned the timing of share purchases by some of Moore’s friends. Shine says the shares were bought less than 30 days before Cardinal announced a stock splitu00e2u20ac”a big governance no-no.Moore counters that the orders had been placed two-and-a-half months earlier, before the split was discussed, and that Welch lost the certificates, causing the delay.

In the third quarter, Welch charged that the company accounted for two separate transactions totaling $195,000, as income,when the money should have gone to reserve for loan losses. The accounting treatment “made Cardinal look like it was performing better than it was,”Welch testified. Moore doesn’t dispute the amountsu00e2u20ac”$45,000 in lease residuals and $150,000 in recoveries on two loans that had charged-off years earlieru00e2u20ac”but says they were accounted for properly.

Welch remained unconvinced, and the following summer wrote a memo to Moore stating that he was uncomfortable signing off on the new SOX certifications if the alleged mistakes weren’t corrected, Shine says. That September,Welch met with management. “The first thing he said was,’Some of you in this room are guilty of fraud,’” Moore says. “And at the end of the meeting, he said, ‘The best thing for me would probably be to leave the bank.’” Welch’s demands, according to Moore, included full bonus and retirement benefits, a severance package, and a letter of recommendation. “Do you think a board is going to accept being placed in a position” like that?

Moore passed Welch’s allegations of impropriety on to his audit committee.”I told the board they had to handle it; that I couldn’t be involved,” he says. The committee appointed an accountant and lawyer to investigate the charges. “They did everything the law requires,” Moore says.When Welch was asked to meet with the investigators, he refused unless he could bring along his own attorney. Bank officials felt that would void their own attorney-client privilege. (Moore says the board’s investigation turned up no signs of wrongdoing.)

After four tries, the board fired Welch, ostensibly because of his unwillingness to cooperate with the investigation.” Four times he was insubordinate to the audit committee and the board,”Moore says.”If I refused to do what the board told me, I?9;d expect them to fire me, too.” Two months later,Welch filed his complaint.

Welch’s chargeu00e2u20ac”that he was fired for raising the allegationsu00e2u20ac” has been disputed strongly by Cardinal and its directors, who recently joined the fray as individuals. But ALJ Stephen Purcell reviewed the audit committee’s minutes, which reportedly indicated that the board had considered firing Welch well before the attorney flap, and ruled that the former CFO was vulnerable to “adverse and discriminatory employment action well before the meeting.” Says Shine: “The bank had already made up its mind to fire him” because he had raised questions. The attorney issue, he adds,”Was just a fau00c3u00a7ade to justify” the firing.

Either way, it’s clear that the case has produced no winnersu00e2u20ac” aside from the lawyers. The boardu00e2u20ac”a group that includes two dentists, two farmers, an attorney, and a local school officialu00e2u20ac”has been accused of botching its handling of the case early. “The audit committee was woefully deficient,” Shine says. “They were good people. But they didn’t understand the finances.”

Shine estimates that Cardinal, a publicly traded holding company for the Bank of Floyd, has spent about $1 million in legal fees on the battle.Moore says the figure is too high, but won 19;t give a total. He indicates the board feels as if it’s being extorted, and says Cardinal will appeal to the Fourth Circuit Court in Richmond if it loses the current appeal with the Labor Department’s administrative review board. “Do you spend the money to defend your position? Or do you go out and pay somebody off?” he asks.

Welch, meanwhile, has had little success trying to find another banking position. Instead, he spends his time doing “various jobs” and fighting to get back his old one. “It’s been a difficult time for David,” Shine says. If he gains reinstatement, however, Welch intends to take the job backu00e2u20ac”no matter how uncomfortable it might be. “David has said that if God opens this door for him, he’ll go back to work and do what he can,” Shine says. “It’s not what I would do, but I’m not David Welch.”