Petition for Writ of Certiorari — Welch v. Chao (No. 08-836)

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WW \ 98-836 JAN2- 2009

No.

CLERK

IN THE

Supreme Court of the United States

DAVID E. WELCH, CPA, PETITIONER

ELAINE L. CHAO, SECRETARY OF LABOR, UNITED

STATES DEPARTMENT OF LABOR, AND CARDINAL

BANKSHARES CORPORATION

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

PETITION FOR WRIT OF CERTIORARI

DONALD F.. MASON, JR.

Counsel of Record

D. BRUCE SHINE

Shine & Mason

483 East Center Street

Suite 201

Kingsport, TN 37660

(423) 246-8433

CURRY & TAYLOR @ (202) 393-4141

QUESTIONS PRESENTED

1. Isa CPA who objectively believes that his company’s

accounting practices produce financial reports which do

not meet generally accepted accounting principles and

could defraud present and potential shareholders,

protected as a whistleblower under the Sarbanes-Oxley

Act?

2. Is the Sarbanes-Oxley Act itselfa “provision of Federal

law relating to fraud against shareholders” which triggers

protection under the Act when a whistleblower reports

its violation?

TABLE OF CONTENTS

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CASES

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Central Bank of Denver, N.A. v. First Interstate

Bank of Denver, N.A., 511 U.S. 164 (1994) wee 21

Collins v. Beazer Homes USA, Inc., 334 F. Supp. 2d

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Livingston v. Wyeth, Inc., 5380 F .8rd 344 (4"" Cir. 2008) ...... 6, 7

National Assn. of Home Builders v. Defenders of

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SEC v. Capital Gains Research Bureau, Inc., 375

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Smith v. Corning, 496 F. Supp. 2d 244 (W. D.N.Y

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OPINIONS BELOW

The published opinion of the United States

Court of Appeals for the Fourth Circuit in David E.

Welch, CPA v. Elaine L. Chao, Secretary of Labor,

United States Department of Labor et al., C.A. No. 07-

1684, decided August 5, 2008, and reported at 536 F.3d

269(4'"" Cir. 2008), affirming the decision of the

Administrative Review Board that the petitioner was

not engaged in protected activity as a whistleblower

under the Sarbanes-Oxley Act, is set forth in the

Appendix hereto(App. 1-21).

The unreported decision of the Administrative

Review Board in David E. Welch, CPA v. Cardinal

Bankshares Corporation, Docket No. 05-064, dated

May 31, 2007, ruling that the petitioner was not

engaged in protected activity as a whistleblower under

the Sarbanes-Oxley Act, is set forth in the Appendix

hereto(App. 22-46).

The unpublished decision of Stephen L. Purcell,

Administrative Law Judge, in David E. Welch, CPA v.

Cardinal Bankshares Corporation, Docket No. 2003-

SOX-15, decided January 28, 2004, finding that the

petitioner engaged in protected activity as a

whistleblower under the Sarbanes-Oxley Act, is set

forth in the Appendix hereto(App. 47-203).

The unpublished order of the United States

Court of Appeals for the Fourth Circuit in David E.

Welch, CPA v. Elaine L. Chao, Secretary of Labor,

United States Department of Labor et al., C.A. No. 07-

1684, filed on October 3, 2008, denying the petitioner

David E. Welch’s timely filed petition for rehearing and

for rehearing en banc, is set forth in the Appendix

hereto(App. 204-205).

JURISDICTION

The decision of the United States Court of

Appeals for the Fourth Circuit affirming the decision of

the Administrative Review Board that the petitioner

was not engaged in protected activity as a

whistleblower under the Sarbanes-Oxley Act, was

decided August 5, 2008. Its further order denying

petitioner’s timely filed petition for panel rehearing and

for rehearing en banc was filed and decided October 3,

2008(App. 1-21;204-205).

This petition for writ of certiorari is filed within

ninety (90) days of October 8, 2008. 28 U.S.C. § 2101(c).

The jurisdiction of this Court is invoked

pursuant to the provisions of 28 U.S.C. § 1254(1).

RELEVANT PROVISIONS INVOLVED

18 U.S.C. $ 1514 A(a)(1) & (2) and (b) [Section 806 of

the Sarbanes-Oaley Act of 2002]:

(a) WHISTLEBLOWER PROTECTION FOR

EMPLOYEES OF PUBLICLY TRADED

COMPANIES.---No company with a class of

securities registered under section 12of the

Securities Exchange Act of 1934 (15 U.S.C. §

781), or that is required to file reports under

section 15(d) of the Securities Exchange Act of

1934 (15 U.S.C. § 78o0(d)), or any officer,

employee contractor, subcontractor, or agent of

such company, may discharge, demote, suspend,

threaten, harass, or in any other manner

discriminate against an employee in the terms

and conditions of employment because of any

lawful act done by the employee—

(1) to provide information, cause information

to be provided, or otherwise assist in an

investigation regarding any conduct which

the employee reasonably believes constitutes

a violation of section[s] 1841, 1848, 1344, or

1348 [of Title 18 of the United States Code],

any rule or regulation of the Securities and

Exchange Commission, or any provision of

Federal law relating to fraud against

shareholders, when the information or

assistance is provided to or the investigation

is conducted by—

(A) a Federal regulatory or law

enforcement agency;

(B) any member of Congress or any

committee of Congress; or

over the employee (or such other person

working for the employer who has the

authority to investigate, discover, or

terminate misconduct); or

(2) to file, cause to be filed, testify, participate

in, or otherwise assist in a proceeding filed

or about to be filed (with any knowledge of

the employer) relating to an alleged violation

of section(s] 1341, 1848, 1344, or 1348 [of Title

18 of the United States Code], any rule or

4 7

regulation of the Securities and Exchange

Commission, or any provision of Federal law

relating to fraud against shareholders.

(b) ENFORCEMENT ACTION.----

(1) IN GENERAL.—A person who alleges

discharge or other discrimination by any

person in violation.of subsection (a) may seek

relief under subsection (c), by----

(A) filing a complaint with the Secretary

of Labor....

STATEMENT

In the wake of the financial collapse of Enron

Corporatien—and Worldcom Corporation in 2002,

congressional investigation revealed employees of these

publicly traded companies’ possessed crucial

information about their fraudulent activities. With

Enron, an employee whistleblower outlined crucial

details about how the company defrauded its

shareholders. With Worldcom, testimony revealed that

an internal auditor had discovered massive fraud

orchestrated by the company’s chief financial officer

and reported it to the board of directors.

These revelations convinced Congress that to

prevent corporate fraud, whistleblowing employees

needed incentives to come forward and break the

corporate “code of — silence.” To encourage

whistleblowers to disclose corporate financial

wrongdoing, protection from retaliation was essential.

When Congress investigated this issue in 2002, it

observed that federal and state laws failed to protect

whistleblowing employees consistently. Each state had

a different level of protection for whistleblowers and

measured retaliation differently “although most

publicly traded companies do business nationwide.” S.

Rep. No. 107-146, at 10(2002). Federal law protected

only whistleblowers who reported certain types of

violations in certain industries. In the face of this

federal/state statutory patchwork, employees had

difficulty predicting whether they would be protected

from retaliation when reporting wrongdoing and this

uncertainty discouraged them from coming forward.

To remedy this incomplete statutory patchwork

of protection for whistleblowers nationwide, to improve

the accuracy and reliability of corporate disclosures

made under the securities laws, and to protect innocent

investors from corporate fraud, Congress on July 30,

2002, enacted the Sarbanes-Oxley Act of 2002, codified

at 15 U.S.C. § 1514A (“SOX” or “the Act”). Employees

of companies with publicly traded shares under the

Securities Exchange Act of 1934 were thus encouraged

to report-securities or accounting fraud when and if

they perceive it.

The Act contains an anti-retaliation provision to

protect whistleblowers from adverse employment

actions as long as the conduct reported is wrongdoing

which the employee reasonably believes constitutes a

violation of 18 U.S.C. §§ 1841(mail fraud), 13843(wire

fraud), 1344(bank fraud), or 1348 (securities fraud); any

rule or regulation of the Securities and Exchange

Commission; or any other provision of Federal law

relating to fraud against shareholders. The

whistleblowing employee can provide information to a

federal regulatory or law enforcement agency, any

member of any committee of Congress, or a person with

supervisory authority over the whistleblower..

Employees are protected if they “provide

information, cause information to be provided, or

otherwise assist in an investigation regarding” such

violations. They do not have to report an actual

violation of the law; instead, they must only

“reasonably believe” that a violation occurred, even if

this belief is ultimately shown to be mistaken and an

actual violation never occurs. Stated another way, an

employee’s belief is unreasonable and_ therefore

unprotected if it is based entirely on unsupported

conjecture about hypothetical future events. His belief

must relate to activity that a reasonable person could

conclude is or is about to become a violation. See

Livingston v. Wyeth, Inc., 530 F.38rd 344, 361(4th Cir.

2008)( Michael, J., dissenting).

Finally, the Occupational Safety and Health

Administration (OSHA), charged with _ initially

investigating whistleblower complaints, can

immediately reinstate the whistleblower if it finds

reasonable cause to believe that retaliation occurred;

and OSHA may also award back pay, special damages

including attorney’s fees, litigation costs, and expert

witness fees.

To gain the protection of SOX, an employee only

has to show that he alerted his publicly traded

employer, a federal regulatory or law enforcement

agency or any member of Congress, to activity which

he reasonably believed constituted a violation of an

enumerated law (such as wire or mail fraud) or of a rule

or other provision of federal law relating to fraud

against a company’s investors.

With this statutory law as background, the facts

adduced below show that petitioner David E. Welch,

CPA (“the petitioner” or “Welch”) was a certified public

accountant since 1993 and a licensed CPA in

Virginia(App. 50). From June, 1997 until August, 1998,

he was a Controller for a physicians’ group. From

September,1998 through February, 1999, he worked as

a staff accountant for Larrowe & Company, a CPA firm

in Galax, Virginia, where he was responsible for bank

audits and other accounting matters, including

preparing tax returns’ for’ corporations § and

individuals(App. 50). Welch also taught accounting and

finance at two colleges(App. 50-51).

While at Larrowe, one of its clients (Cardinal

Bankshares) offered the petitioner the position of Chief

Financial Officer(App. 51). The respondent Cardinal

Bankshares together with its subsidiary company Bank

of Floyd (“the respondent” or “Cardinal’’) is a bank

holding company and a publicly traded corporation

listed on the board of the National Association of

Security Dealers (“NASDAQ”)(App. 51). It was created

to allow Bank of Floyd to take advantage of Cardinal’s

widely recognized name and to enable the Bank to

transfer part of its capital to the holding company to

avoid some of Virginia’s bank franchise taxes(/d.).

During this time, Cardinal had about 600

shareholders(/d.).

As Cardinal’s CFO, petitioner was responsible

for monitoring and reviewing journal entries posted to

the general ledger accounts for the bank and the

holding company. He maintained all the general ledger

accounts and prepared all of the financial statements

for the holding company(App. 51-52).

During 2001 and prior to SOX’s enactment on

July 30, 2002, Welch found evidence suggesting that R.

Leon Moore (“Moore”), Cardinal’s President/CEO and

the chairman of its board of directors, had engaged in

insider trading of Cardinal’s shares, was improperly

overriding the company’s internal financial controls,

was allowing unauthorized personnel access to the

company’s general ledger accounts and had improperly

treated a $195,000.00loan loss recovery as income with

the net effect of improperly inflating Cardinal’s income

for the third quarter of 2001, misleading present and

potential investors(App. 52-56).

Welch reported the incidents of insider trading

by Moore to the SEC by e-mail around March 29,

2002(App. 56). After SOX was enacted on July 30, 2002,

petitioner continued to voice his disagreement with

Moore’s conduct in managing Cardinal’s financial

information, data which Welch reasonably believed

Moore was confecting for his (and Cardinal’s) benefit

and to the detriment of the company’s present and

potential shareholders(App. 56-57).

On August 2, 2002, petitioner wrote the

company’s outside auditor that as Cardinal’s CFO he

could not sign a “representation letter’ acknowledging

Cardinal’s consolidated financial statements were

prepared in conformity with generally accepted

accounting principles (GAAP) and that there were no

violations of laws or regulations(App. 57-58). As he

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wrote, entries were being made in Cardinal’s general

financial ledger without his knowledge or approval. In

fact, Moore was listed with the auditor as the CFO of

Cardinal instead of Welch, and he (Welch) was

freauently bypassed during the auditor’s search for

finaiicial information(App. 58). Finally, he advised that

[djuring the first half of 2002, the media has

made us-~ acutely aware of corporate

wrongdoings. As a result, this past Tuesday,

President Bush signed into law a bill that

contains some pretty harsh penalties for

accounting practices that could result in financial

statements being unfairly presented. As a result,

I need a better level of comfort before signing a

representation [letter| such as yours.

(App. 58).

Twelve days later, Welch restated these

coneerns in an e-mail to Moore, Cardinal’s CEO,

advising him that he (Welch) could not certify

Cardinal’s financial statements filed with the SEC

(SEC Form 10-QSB) for the second quarter of

2002(App. 60-61). As an example of misleading journal

entries, the petitioner referred to Moore’s approval! of

an erroneous entry of $195,000 in loan loss recovery as

income(App. 60-61). In addition, he noted that in 2002,

Moore reversed certain expenses which he had already

charged against income in 2001, contradictory

accounting which did not meet GAAP and showed that

the bank was “‘managing’ net income which [is]

unethical and is now seriously illegal’(App. 61 ).

On September 13, 2002, petitioner wrote Moore

to tell him that because of the company’s misstated

2001 income, he would not be able to certify Cardinal’s

financial statements in SEC Form 10-QSB for the third

quarter of 2002(App. 61-62). He advised that the bank’s

income for the third quarter of 2001 should be restated

to properly account for the $195,000 loan recoveries “in

order to avoid the unfair presentation of financial

statements which could lead a reasonable investor to

make a decision they might otherwise not make’’(App.

62-63). As he reasoned, these overstatements of income

for 2001 “made Cardinal look like it was really

performing better than it was” and convinced him as a

CPA that these untrue statements may have misled

investors resulting in the sudden increase in the bank’s

stock price between early September and late October

of 2001 (App. 65-66).

For these reasons, petitioner made clear that his

certification of Cardinal’s financial reports would not

satisfy § 906 of SOX (18 U.S.C. § 1350), which requires

a certification that “(1) the report fully complies with

the requirements of Section 13(a) or 15(d) of the

Securities Exchange Act of 1934, and (2) the

information contained in the Report fairly presents, in

all material respects, the financial condition and results

of operations of the Company as of and for the periods

covered in the Report” (App. 68).

The petitioner met with the bank’s senior

personnel, including Moore, on September 20, 2002, to

explain SOX’s reporting requirements and _ its

relationship to Cardinal’s suspect accounting

practices(App. 80-81). A dispute over tape recording

the meeting led some to leave; Welch continued the

meeting and explained to those present the

requirements of SOX and his refusal to certify the

company’s financial reports without restating the 2001

data regarding the $195,000 in loan loss recoveries(App.

81-86).

Cardinal’s counsel scheduled a meeting with the

petitioner on September 25, 2002, to investigate his

allegations of fraud. He told Welch to bring the tape of

the earlier meeting(App. 85-86). The petitioner

postponed this meeting until he talked to his

attorney(App. 86-88). The bank thereupon suspended

the petitioner for refusing to meet with its Audit

Committee, even though none of this Committee’s

members were going to be present at petitioner’s

scheduled meeting with Cardinal’s counsel(App. 95).

On October 1, 2002, Cardinal’s Audit Committee

determined petitioner’s attorney would not be allowed

to attend its meeting and because of petitioner’s alleged

unwillingness to meet with it unless his attorney was

present, the Committee terminated him(App.100;133).

A board of directors’ meeting later that day determined

that Welch was unwilling or unable to fulfill his

responsibilities as CFO and it unanimously voted to

terminate his employment(App. 133).

On December 19, 2002; the petitioner filed a

whistleblower complaint with OSHA, U.S. Department

of Labor, alleging that Cardinal had terminated his

employment as CFO in violation of the anti-retaliation

provisions of 18 U.S.C. §1514A(a)(1)(App. 23). OSHA

dismissed his complaint on February 4, 2003(App. 48).

The petitioner appealed and an Administrative Law

Judge (ALJ) conducted a de novo evidentiary hearing

on August 25-26, 2003(App. 48-49).

On January 28, 2004, the ALJ issued his

recommended decision concluding Cardinal had

violated SOX when it terminated the petitioner(App.

47-203).The ALJ found that three of the petitioner’s

allegations against Cardinal about its accounting

practices were based upon his reasonable belief that

SOX violations were being committed and that his

efforts to bring these matters to light constituted

“protected activity” within SOX’s anti-retaliation

provisions(App. 142-143).

First, the ALJ found that Welch reasonably

believed the company’s incorrect recording of $195,000

in loan recoveries as income was improper and could

mislead potential investors(App. 148-146). As a CPA,

Welch followed the Federal Reserve’s instructions for

quarterly call reports which mandate that such loan

recoveries “can never go directly against income”(/d.).

Indeed, Larrowe, the bank’s outside auditor, changed

these entries when the petitioner brought it to its

attention (App. 143). Since these improper entries

overstated income for the third quarter of 2001, it was

reasonable for the petitioner as a CPA to believe that

this material misstatement of Cardinal’s income

required restatement before he could certify the

company’s financial reports(App. 145-146).

Second, the ALJ found petitioner reasonably

believed the outside auditor did not communicate with

him as Cardinal’s CFO regarding financial matters

entrusted to him by his job description(App. 150).

Instead, the outside auditor regularly communicated

with Moore, Cardinal’s CEO, concerning financial

reporting and about investigating § Welch’s

complaints(App. 149-152 ).

Third, the ALJ found that it was reasonable for

petitioner, as Cardinal’s CFO, to believe that it

maintained inadequate internal controls over its

financial information because too many individuals

outside of Cardinal’s Finance Department were making

entries in the bank’s general ledger without his review

or knowledge(App. 152-156 ). As Welch’s preof showed,

the $195,000 in loan loss recoveries and other sundry

credits were entries which overstated the company’s

income, were made by persons with no accounting

experience and were inconsistent with GAA’ which

requires “that income and expenses be matched against

the period in which they are incurred”(App. 154).

The ALJ found that all of these activities were

protected by SOX, were known to Cardinal’s top

management and were contributing factors in the

petitioner’s suspension and his ultimate termination on

October 1, 2002(App. 156-164). As the ALJ found, “[t]he

evidence establishes that [Cardinal’s} ‘investigation’ of

Welch’s. complaints was orchestrated by Leon Moore,

acting in concert with [the outside auditor] and [the

bank’s counsel], in such a way that [the bank] could

justify [Welch’s] termination’ (App.157-158). Moreover,

Cardinal had not adduced clear and convincing evidence

that it would have discharged the petitioner

irrespective of his having engaged in this protected

activity(App.164-165).

As the ALJ concluded, the petitioner

has demonstrated by a preponderance of the

evidence that he was fired by [Cardinal] because

he complied with his duty to disclose information

governed by [SOX]....[and Cardinal] has...failed

to produce sufficient evidence to clearly and

convincingly demonstrate that its motive for

firing Welch was unrelated to his protected

activity.

(App.173). As relief, the ALJ ordered Cardinal to

reinstate Welch and pay him back pay with interest,

special damages, attorney fees and expenses(App. 173-

176). |

Cardinal appealed this decision to the

Administrative Review Board(ARB)(App. 23). The

ARB ruled that regardless of how Cardinal classified

the $195,000 on its books, it was money recovered

which it previously did not have(App. 37). It therefore

ruled “that an experienced CPA/CFO like Welch could

not have reasonably believed that the third quarter

SEC report presented potential investors with a

misleading picture of Cardinal’s financial

condition”(App.33-38). The ALJ’s finding to the

contrary was thus legal error(App. 37).

Welch further argued that Cardinal’s misleading

financial reports failed to meet GAAP and generally

accepted accounting standards (GAAS), that these

shortcomings constitute violations of SOX itself since

SOX’s provisions protect whistleblowers who report a

violation of ‘any... provision of Federal law relating to

fraud against shareholders,” and that financial reports

which do not meet GAAS and GAAP are presumptively

fraudulent and misleading (App. 37-38). The ARB

rejected this argument as a wholesale rewriting of SOX

because it concluded that Congress could not have

intended “to extend protection to those employees who

report violations of GAAS, GAAP or FFIEC [Federal

Financial Institutions Examinations Council]

standards’’(App. 38).

Nor did the ARB think Welch’s asserted lack of

access to the company’s outside auditor or his asserted

lack of internal controls could have led to his reasonable

belief Cardinal was violating any federal law relating to

fraud against shareholders(App. 38-42). It therefore

reversed the ALJ’s decision in favor of petitioner

because he had not demonstrated that he had engaged

in activity protected under SOX(App. 42).

Welch appealed the ARB’s decision to the court

of appeals for the Fourth Circuit(App. 1-21). As he had

done before the ARB, the petitioner argued that prior

to SOX’s enactment, the Securities Exchange Act of

1934 together with its regulations and rules imposed

GAAS and GAAP upon the financial reports required

to be filed by companies whose shares are publicly

traded. When Congress enacted SOX in 2002, it further

provided that financial reports adjusted for accuracy by

accounting firms comply with GAAP. See 15 U.S.C. §

74(i). Thus when the petitioner apprehended that

Cardinal had _ incorrectly credited the $195,000 as

income for 2001, as a CPA who had _ performed

numerous bank audits, he had a reasonable belief that

this inaccurate entry did not comply with GAAS and

GAAP, violating the above mentioned securities laws

as well as SOX itself, preventing him from signing

Cardinal’s SEC Form10-QSB for the third quarter of

2001.

The court of appeals affirmed the ARB’s

decision, ruling that petitioner failed to explain to the

ARB (or to it) how he could reasonably regard

Cardinal’s conduct as violating any of the laws listed in

SOX(App. 16-17;20-21). In reaching this result, the

court rejected Welch’s argument that GAAS and

GAAP were some of the provisions of Federal law

relating to fraud against shareholders which SOX

referenced in its own provisions and which should have

been enforced here(/d.).

On October 3, 2008, the court of appeals denied

the petitioner’s timely filed petition for panel rehearing

or for rehearing en banc(App. 204-205).

REASONS FOR GRANTING THE PETITION

The Decision Below Nullifies The Sarbanes-Oxley

Act By Failing To Provide Whistleblowers With

The Expanded (Protection Which Congress

Intended.

Upon its enactment in 2002, SOX mandated

that corporate accounting protocol adhere to GAAP and

GAAS and this requirement became part of the fabric

of securities laws and regulations aimed at preventing

investor fraud with publicly traded companies. SOX

itself thus became one of those “provision[s] of Federal

law relating to fraud against shareholders” which

triggers whistleblower protection under Section 806 of

SOX when an employee reports its violation.

Accordingly, when petitioner apprehended that

Cardinal had incorrectly credited $195,000 as income for

2001 and was improperly overriding the company’s

internal financial controls to allow unauthorized

personnel access to the company’s general ledger

accounts, he as a CPA who had performed numerous

bank audits had an objectively reasonable belief that

this inaccurate entry of financial information did not

comply with GAAS and GAAP and violated the

securities laws as well as SOX itself. He was therefore

right as the bank’s CFO to refuse to sign Cardinal’s

SEC Form10-QSB for the third quarter of 2001 and to

report these improprieties to his authorities in the

bank. Because petitioner was engaging in protected

activity under Section 806 of SOX, he was entitled to

the whistleblower protection it provided when he was

ultimately terminated because of his actions.

Petitioner made this precise argument before

both the court of appeals and the ARB. Yet both

tribunals failed to appreciate that when SOX was

enacted in 2002, it built upon the stringent reporting

requirements of the Securities Exchange Act of 1934

together with its regulations and rules which imposed

GAAS and GAAP upon the financial reports required

to be filed with the SEC by companies whose shares

are publicly traded. With SOX, Congress increased and

applied these standards for accuracy and honesty in

SEC filings onto corporate accounting practices by

criminalizing dishonest, misleading financial reporting

which defrauds a company’s shareholders. SOX’s own

reporting requirements—including GAAS and GAAP--

-are now part of the “provision[{s] of Federal law

relating to fraud against shareholders” within Section

806 of SOX which triggers its whistleblower protection

when an employee reports their violation.

Neither the court of appeals nor the ARB

grasped this logical, fundamental fact about SOX. The

ARB rejected petitioner’s argument as a wholesale

rewriting of SOX because it concluded that Congress

could not have intended “to extend protection to those

employees who report violations of GAAS, GAAP or

FFIEC [Federal Financial Institutions Examinations

Council] standards”’(App. 38). The court of appeals

affirmed the ARB’s disposition holding that petitioner

failed to explain to it or to the ARB how he could

reasonably regard Cardinal’s conduct as violating any

of the laws listed in SOX(App. 16-17;20-21)

The failure by the court of appeals and the ARB

to appreciate this logical, fundamental fact about SOX,

i.e., that a reasonably objective belief that SOX’s own

reporting requirements including GAAS and GAAP

were violated is enough to trigger Section 806's

whistleblower protection, nullifies SOX’s plain

language, constricts the dimensions of “protected

activity” which invokes Section 806's whistleblower

provisions and frustrates Congress’ intent that

whistleblowers be given more protection from

retaliation than previously provided to encourage their

coming forward with crucial information which could

avoid the collapse of corporations like Enron and

Worldcom and the ensuing harm to shareholders.

Prior to SOX’s enactment in 2002, the Securities

Exchange Act of 1934 together with its rules and

regulations imposed GAAS and GAAP upon the

financial reports filed by publicly traded companies.

Not only was GAAP imbedded in the reporting

requirements set out by §8§ 13(a) and (b) of the

Securities Exchange Act (15 U.S.C. § 78m) but also

rules promulgated pursuant thereto mandate that

accurate reporting for banks meant adherence to

“GAAP or FFIEC standards.” See 17 Fed. Reg.

41,879(June 20, 2002).

In addition, Regulation S-B, 17 C.F.R. § 228.310,

Note 1, applicable to Cardinal as a small business,

provides that “[flinancial statements of a small business

issuer, its predecessors or any business to which the

small business issuer is a successor shall be prepared in

accordance with generally accepted accounting

principles in the United States” (emphasis supplied).

Furthermore, SEC’s Regulation S-X, 17 C.F.R. § 210.4-

O01(a)(1)(2001), applicable to larger institutions,

provides that financial statements filed with the

Commission which are not prepared in accordance with

generally accepted accounting principles will be

presumed to be misleading or inaccurate....” (emphasis

supplied).

Congress built upon these requirements when it

enacted SOX in July of 2002. Section103 (15 U.S.C. §

7213(a)(2)(A)(ID(bb)) mandates that a company’s

financial statements be prepared “in accordance with

generally accepted accounting principles;’Section 108

(15 U.S.C. § 77s(b)(1)A){iv)) encourages the adoption of

high quality accounting principles which are

“appropriate in the public interest and for the

protection of investors;” Section 401 (15 U.S.C. §

78m(i)) requires that any “correcting adjustments” to

any financial report or statement be made by a

registered public accounting firm “in accordance with

generally accepted accounting principles and the rules

and regulations of the Commission;” Section 302 (15

U.S.C. § 7241(a)) makes petitioner as CFO responsible

for certifying as accurate and based upon adequate

internal controls any periodic financial report of the

bank; and Section 906 (18 U.S.C. § 1350) makes

petitioner responsible for the accuracy of periodic

financial reports under the penalties of fine and

incarceration.

This Court has consistently held that any effort

to construe a statute, including the securities laws,

must begin with the language of the statute itself.

Lewis v. United States, 445 U.S. 55, _ (1976). Ernst &

Ernst v. Hochfelder, 425 U.S. 425 U.S. 185, 197(1976).

SOX’s unmistakable language imposes upon Cardinal

and its CFO the unwavering duty to maintain adequate

internal controls within the bank so that it can file its

periodic financial reports with accuracy, transparency

and adherence to GAAP and GAAS. It is what the

above identified provisions of SOX mandate.

In light of these provisions, petitioner rightly

perceived as a CPA and the bank’s CFO that the bank’s

internal controls were inadequate and that the $195,000

loan loss recovery had been improperly reported as

income for 2001, in violation of GAAP and GAAS and

therefore SOX itself. His refusal to certify the bank’s

financial report for the third quarter of 2001 therefore

had a solid basis in fact and he was entitled to Section

806’s whistleblower protection when he reported these

violations to his authorities.

The touchstone for interpreting SOX is the

prevention of investor fraud. As this Court observed in

an analogous context, by placing iesponsibility in

corporate officers to insure the accuracy and

truthfulness of corporate filings, investors are

protected from misleading information, substituting “a

philosophy of full disclosure for the philosophy of caveat

emptor.” Central Bank of Denver, N.A. v. First

Interstate Bank of Denver, N.A., 511 U.S. 164,

171(1994). Moreover, where Congress intends that

securities legislation like SOX be aimed principally at

preventing shareholder fraud, its provisions should be

construed “not technically and restrictively, but

flexibly to effectuate its remedial purposes.” Affiliated

Ute Citizens v. United States, 406 U.S. 128, 151(1972)

quoting SEC v. Capital Gains Research Bureau, Inc.,

375 U.S. 180, 195(1963). See National Assn. of Home

Builders v. Defenders of Wildlife, 551

USS. ,____(2007)(Steven, J., dissenting).

Petitioner’s conduct falls within that plain

purpose of preventing investor fraud. Having

reasonably apprehended a violation of SOX itself by the

bank’s lack of internal controls and its filing of a

quarterly report which did not meet GAAP and GAAS,

he engaged in protected activity when he reported

these violations and was entitled to the protection

afforded by Congress when it enacted Section 806 of

SOX. The court of appeals and the ARB were wrong to

suppose that this was an unwarranted expansion of

SOX or that petitioner had wrongly placed reliance on

GAAP and GAAS in explaining his refusal to sign off

on the bank’s report. Accord, Smith v. Corning, 496 F.

Supp. 2d 244, 249-250(W.D.N.Y. 2007)(denying motion

to dismiss); Collins v. Beazer IIomes USA, Inc., 334 F.

Supp. 2d 1365, 1377-1388(N.D. Ga. 2004)(summary

judgment denied).

The result below not only nullifies SOX’s plain

language and its remedial purposes but also constricts

the “protected activity” cognizable under Section 806 to

such an extent as to repeal the statute altogether,

frustrating Congress’ intent that whistleblowers be

given more protection from retaliation than previously

provided and that shareholders receive accurate, timely

information about the financial health of the companies

they own.

The decision warrants this Court’s review

because it typifies a consistent line of decisions of

several ARBs and this court of appeals which have

denied whistleblowers relief at every turn. After all,

Congress intended to respond post-Enron to

a culture, supported by law, that discourage([s]

employees from reporting fraudulent behavior

not only to the proper authorities...but even

internally. This “corporate code of silence” not

only hampers investigations, but also creates a

climate where ongoing wrongdoing can occur

with virtual impunity. The consequence of this

corporate code of silence for investors of publicly

traded companies, in particular, and for the stock

market, in general, are serious and adverse and

they must be remedied.

S. Rep. No. 107-145, at 10(2002)(emphasis supplied).

Yet the court of appeals has essentially resurrected the

same bad law and the same culture of silence which

Congress intended to extinguish when it enacted SOX.

Moreover, as a thorough study recently made

clear, there is not one reported decision where a

whistleblower has been awarded the ultimate remedy

of reinstatement to his job as a result of SOX. See

Moberly, Richard E., Unfulfilled Expectations: An

Empirical Analysis of Why Sarbanes-Oxley

Whistleblowers Rarely Win, 49 Will. & Mary L. Rev.

65(2007) passem. The federal courts and the various

ARBs hearing whistleblower complaints have rendered

SOX a sham. The Court should take this opportunity to

reverse this trend and breath new life into this

statutory scheme consistent with Congress’ intent so

that the lower federal courts and the federal

administrative bodies enforce its provisions instead of

reward secrecy and malfeasance.

The result below is also troublesome for the

signal it sends to the corporate community about

responsible, transparent financial reporting in the post-

Enron era. It further weakens an already moribund

enforcement scheme of the last eight years by

punishing whistleblowers and the investors. who °

depend on them for exposing fraud from the inside. The

recent irregularities and collapse of under-regulated

investment firms on Wall Street as well as at IndyMac

Bank are persuasive proof that this kind of decision

making, which guts Congress’ remedial legislation and

leaves investors on their own with few effective

remedies, is unprincipled, unsupported by the law and

wrong.

CONCLUSION

For all of these reasons identified herein, a writ

of certiorari should issue to review the judgment of the

United States Court of Appeals for the Fourth Circuit

and, ultimately, to vacate and reverse that judgment

and enter a new judgment determining that petitioner

engaged in protected activity within SOX and is

therefore entitled to reinstatement, back pay with

interest, special damages, attorney fees and expenses.

This matter should be remanded to the Administrative

Law Judge and/or the Administrative Review Board

for the United States Department of Labor, with

instructions that a judgment enter in petitioner’s favor

as was originally entered in this case. Finally, it is

requested that this Court provide petitioner with such

other relief as is fair and just in the circumstances of

this case.

Respectfully submitted,

Donald F. Mason, Jr.

Counsel of Record

D. Bruce Shine

Shine & Mason

433 East Center Street

Suite 201

Kingsport, TN 37660

(423)246-8433

(any footnotes trail end of each document)

No. 07-1684

UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

DAVID E. WELCH, CPA,

Petitioner,

ELAINE L. CHAO, SECRETARY OF LABOR,

UNITED STATES DEPARTMENT OF LABOR,

Respondent,

CARDINAL BANKSHARES CORPORATION,

Intervenor-Respondent.

GOVERNMENT ACCOUNTABILITY PROJECT;

NATIONAL WHISTLEBLOWER CENTER;

TAXPAYERS AGAINST FRAUD,

Amici Supporting Petitioner,

AMERICAN ASSOCIATION OF BANK

DIRECTORS; VIRGINIA ASSOCIATION OF

COMMUNITY BANKS; VIRGINIA BANKERS

ASSOCIATION,

Amici Supporting Respondent,

SECURITIES AND EXCHANGE COMMISSION,

Amicus Curiae.

May 14, 2008, Argued

. August 5, 2008, Decided

On Petition for Review of an Order of the United

States Department of Labor. (2003-SOX-15).

COUNSEL: ARGUED: David B. Shine, Donald

Franklin Mason, Jr... SHINE & MASON, Kingsport,

Tennessee, for Petitioner. Barbara Eby Racine,

UNITED STATES DEPARTMENT OF LABOR,

Washington, D.C., for Respondent. Joseph Michael

Rainsbury, LECLAIR RYAN, PC, Roanoke, Virginia,

for Intervenor. ON BRIEF: Gregory F . Jacob, Solicitor

of Labor, Steven J. Mandel, Associate Solicitor, Ellen

R. Edmond, Counsel for Whistleblower Programs,

UNITED STATES DEPARTMENT OF LABOR,

Office of the Solicitor, Washington, D.C., for

Respondent. Douglas W. Densmore, LECLAIR

RYAN, PC, Roanoke, Virginia; Betty Southard

Murphy, Marc A. Antonetti, BAKER & HOSTETLER,

LI.P, Washington, D.C., for Intervenor. Paul Taylor,

TAYLOR & ASSOCIATES, Burnsville, Minnesota;

Jason M. Zuckerman, THE EMPLOYMENT LAW

GROUP, PC, Washington, D.C., for The Government

Accountability Project, The National Whistleblower

Center, and Taxpayers Against Fraud, Amici

Supporting Petitioner. Arthur P. Strickland, Roanoke,

Virginia, for American Association of Bank Directors,

Amicus Supporting Respondent. A. Peter Brodell,

WILLIAMS MULLEN, PC, Richmond, Virginia;

Joseph E. Spruill, III, VIRGINIA BANKERS

ASSOCIATION, Glen Allen, Virginia, for Virginia

Bankers Association and Virginia Association of

Community Banks, Amici Supporting Respondent.

Brian G. Cartwright, General Counsel, Andrew N.

Vollmer, Deputy General Counsel, Jacob H. Stillman,

Solicitor, Mark Pennington, Assistant General Counsel, .

SECURITIES AND EXCHANGE COMMISSION,

Washington, D.C., for Securities and Exchange

Commission, Amicus Curiae.

JUDGES: Before MOTZ, Circuit Judge, HAMILTON,

Senior Circuit Judge, and Claude M. HILTON, Senior

United States District Judge for the Eastern District of

Virginia, sitting by designation. Judge Motz wrote the

opinion, in which Senior Judge Hamilton and Senior

Judge Hilton joined.

OPINION

DIANA GRIBBON MOTZ, Circuit Judge:

David E. Welch appeals a final order of the

Administrative Review Board (ARB) finding that his

discharge by Cardinal Bankshares Corporation did not

violate the whistleblower protection provision of the

Sarbanes-Oxley Act. For the reasons set forth within,

we affirm.

Cardinal Bankshares Corporation is a bank holding

company with its common stock listed on the NASDAQ

Bulletin Board. As of December 31, 2001, Cardinal had

outstanding over 1.5 million shares of common stock,

held by approximately 600 stockholders of record.

Cardinal is the sole owner of a single financial

institution, the Bank of Floyd. Cardinal and the Bank of

Floyd share a Board of Directors and managing

officers, and Ronald Leon Moore serves as the Chief

Executive Officer of both entities. Hereinafter, we

refer to the Bank of Floyd and_ Cardinal

interchangeably as "Cardinal."

Welch, the petitioner in this case, is licensed as a

certified public accountant in Virginia and holds a

bachelor's and a master's degree in_ business

administration. Welch began working for Cardinal in

1999 as a part-time accounting officer, and, in 2000,

Moore hired Welch as Cardinal's Chief Financial Officer

(CFO). Welch's responsibilities as CFO of Cardinal

included preparing and reviewing entries on Cardinal's

general ledger accounts; devising and implementing

accounting procedures; and preparing various reports

and financial statements, including the 10-QSB

quarterly reports and 10-K annual reports that

Cardinal is required to submit to the Securities and

Exchange Commission (SEC), see 15 U.S.C. §§ 781-78m

(2000).

Welch came to believe that Cardinal's accounting

practices were seriously deficient in several respects.

According to Welch, Moore and others who lacked

accounting expertise routinely made entries in

Cardinal's general ledger; Welch asserts that this

practice itself violated generally accepted accounting

principles (GAAP). He also contends that this practice

resulted in ledger entries that violated GAAP.

Most notably, on one _ specific occasion, Cardinal

recovered two loans that it had previously written off,

expecting that they would not be recouped. Cardinal

recorded the unexpected recovery of these written-off

loans, totaling $ 195,000, as income; Welch maintains

that GAAP does not permit such recovered loans to be

reported as income and instead requires that they be

listed on a company's loan reserve account. Welch

attempted to change the ledger entries so that the loans

would be recorded in the loan reserve account instead

of as income, but Moore refused to authorize these

changes. According to Welch, these incorrect entries

caused Cardinal! to overstate its year-to-date income by

$ 195,000 in its 2001 third-quarter 10-QSB report to the

SEC. Larrowe & Co., PLC, Cardinal's independent

auditor, eventually corrected these entries in Cardinal's

annual report during the 2001 year-end audit, but

neither Cardinal nor Larrowe & Co. ever submitted a

corrected third-quarter 10-QSB report to the SEC.

Finally, Welch claims that Moore would often

communicate directly with Larrowe & Co. about

financial matters without including Welch. Welch

alleges that by so excluding him, Moore restricted his

access to Larrowe & Co., and that this "restricted

access" prevented him from performing h’s tasks as

CFO and prevented him from confirming the accuracy

of Cardinal's financial reports.

Welch forcefully communicated his concerns about

these assertedly improper accounting practices in

multiple formal memoranda to Moore and others

immediately following the July 30, 2002, effective date

of the Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204,

116 Stat. 745. Welch also contends that he raised these

concerns orally with Moore and others as they arose in

2001.'

On August 2, 2002, Welch informed Larrowe & Co. in

writing that he could not sign a representation letter to

Larrowe & Co. confirming that Cardinal provided

Larrowe & Co. with accurate financial information for

the first and second quarters of 2002, because Moore

and others had made ledger entries without his

supervision and because Moore and Larrowe & Co. had

excluded him from their ‘communications loop" on

various issues.

On August 14, 2002, Welch refused to certify Cardinal's

2002 second-quarter 10-QSB report to the SEC, as

required by the Sarbanes-Oxley Act. In a memorandum

explaining his refusal to certify the quarterly report,

Welch claimed that he could not certify to the accuracy

of the company's financial reports because, among other

concerns, unauthorized persons had recorded ledger

entries. Welch identified the entry as income of the $

195,000 in recovered loans as evidence of the

inaccuracies he believed this practice had caused.

Moore ultimately certified Cardinal's quarterly report

himself, because Welch refused to do so.

On September 13, 2002, Welch submitted another

formal memorandum to Moore, insisting that Cardinal

needed to change its accounting practices before Welch

could certify the pending 2002 third-quarter 10-QSB

report to the SEC. Welch again complained about the

entry of the $ 195,000 in recovered loans as income, this

time arguing that Cardinal needed to correct its 2001

third-quarter 10-QSB report that listed the $ 195,000 as

income; Welch also repeated his complaints that Moore

had excluded him from communications with Larrowe

& Co. and that unauthorized persons had made ledger

entries.

\. Following this barrage of criticism, Welch's relationship

with Moore deteriorated rapidly. On September 17,

2002, Moore called a meeting of Cardinal's Board of

Directors to discuss Moore's dissatisfaction with Welch.

Moore related to the Board the content of Welch's

memoranda and his belief that Welch's concerns were

unfounded. Moore also reported that in August 2002,

state examiners had found numerous errors in a

quarterly call report that Welch had prepared and

submitted to the Federal Reserve and the Virginia

State Corporation Commission. In addition, Moore

related that the examiners had commented that many

of the "charts, graphs, and spreadsheet reports"

prepared by Welch were "unnecessary and time-

consuming.” Moore advised the Board that "the

situation has deteriorated to the point that Mr. Welch

seems to have become disaffected and apparently is

unwilling or unable to do what needs to be done to

comply with the law." The Board decided to ask the

Audit Committee's legal counsel, Douglas Densmore,

and outside auditor, Michael Larrowe, to investigate

and prepare a report on Welch's assertions, including

his claim that Cardinal needed to correct its third-

quarter 2001 SEC report because Cardinal had

improperly reported the $ 195,000 in recovered loans as

income.

On September 20, 2002, Welch held what he

characterized as a "Sarbanes-Oxley briefing" for senior

personnel at Cardinal. During this briefing, Welch

alleged that three Cardinal employees were "parties to

fraudulent acts," outlined his belief that Cardinal's

accounting practices violated the Sarbanes-Oxiey Act,

and proposed that he leave Cardinal quietly upon

receipt of a generous severance package. Following the

meeting, Densmore and Larrowe attempted to meet

with Welch to discuss his charges, but Welch

repeatedly refused to meet with them without his

personal attorney.

At a meeting of Cardinal's Board of Directors on

September 25, 2002, the Board voted to suspend Welch

without pay pending the results of Densmore and

Larrowe's investigation. Following his suspension, the

Board ordered Welch to meet with Densmore and

Larrowe without counsel to discuss his accusations, but

Welch again refused to meet without his attorney.

On October 1, 2002, Densmore and Larrowe presented

the results of their investigation to the Board. They

concluded that Welch's concerns regarding Cardinal's

accounting practices lacked merit. They also concluded

that Welch had seriously breached his fiduciary duty to

Cardinal by refusing to meet with them to discuss his

charges, and they recommended that Cardinal

discharge him. The Board unanimously voted to

discharge Welch, effective immediately.

Welch then filed a complaint with the Occupational

Safety and Health Administration (OSHA), alleging

that Cardinal had dismissed him in violation of the

whistleblower protection provision of § 806 of the

Sarbanes-Oxley Act, 18 U.S.C. § 1514A (Supp. V 2005).

Welch alleged that his various communications to

Cardinal constituted protected activity under the

Sarbanes-Oxley Act and that Cardinal fired him

because of this protected activity. Based on an

investigation by OSHA, the Secretary of Labor

dismissed the complaint, finding that, although Welch

engaged in protected activity, Cardinal did not fire him

because of that activity. Rather, the Secretary found

that Cardinal fired Welch because Welch refused to

meet with Densmore and Lar-rowe without counsel,

which the Secretary concluded constituted a legitimate

reason for Welch's discharge.

Welch appealed and requested a hearing before an

administrative law judge (ALJ). See 29 C.F.R. 8

1980.106 (2007). Following the hearing, the ALJ issued

a recommended decision and order, finding that at least

three of the concerns that Welch communicated to

Cardinal constituted protected activity under the

Sarbanes-Oxley Act. Specifically, the ALJ found that

the Sarbanes-Oxley Act protected Welch's

communications about: (1) Cardinal's entry of the $

195,000 in recovered loans as income; (2) Cardinal's

general practice of allowing persons without accounting

expertise to make ledger entries; and (8) Welch's

"restricted access" to Larrowe & Co. The ALJ found

that Cardinal fired Welch because of these protected

activities and ordered him reinstated with back pay.

The ALJ later issued a supplemental recommended

decision and order, stipulating the amount of back pay

to which the judge found Welch entitled.

Cardinal appealed the ALJ's order to the ARB, which

reversed, finding as a matter of law that none of

Welch's communications constituted protected activity

under the Sarbanes-Oxley Act and dismissing Welch's

complaint. Welch appeals.

Il.

The Sarbanes-Oxley Act creates "whistleblower"

protection for employees of publicly-traded companies

by prohibiting employers from retaliating against

employees because they provided information about

potentially unlawful conduct. Specifically, the Sarbanes-

Oxley Act provides:

No [publicly-traded company], or any officer [or]

employee ... of such company, may discharge . . .

an employee ... because of any lawful act done

by the employee —

10a

(1) to provide information .. . regarding any

conduct which the employee reasonably believes

constitutes a violation of section 1341 [mail

fraud], 1343 [wire fraud], 1344 [bank fraud], or

1848 [securities fraud], any rule or regulation of

the [SEC], or any provision of Federal law

relating to fraud against shareholders, when the

information ...is provided to...

...a person with supervisory authority over the

employee....

18 U.S.C. § 1514A(a); see also Livingston v. Wyeth, Inc.,

520 F.3d 344, 351 (4th Cir. 2008); Allen v. Admin.

Review Bd., 514 F.3d 468, 475 (5th Cir. 2008).

The whistleblower protection provision of the

Sarbanes-Oxley Act adopts the burden-shifting

framework applicable to whistleblower claims brought

under the Wendell H. Ford Aviation Investment and

Reform Act for the 21st Century, 49 U.S.C. § 42121(b)

(2000). See 18 U.S.C. § 1514A(b). Accordingly, an

employee bears the initial burden of making a prima

‘facie showing of retaliatory discrimination; the burden

then shifts to the employer to rebut the employee's

prima facie case by demonstrating by clear and

convincing evidence that the employer would have

taken the same personne! action in the absence of the

protected activity. 49 U.S.C. § 42121(b){2)(B).

The Department of Labor (DOL) regulations

implementing § 1514A provide that in order to make a

prima facie showing, an employee's complaint must

allege that: (1) the employee engaged in protected

activity; (2) the employer’ knew, actually or

lla

constructively, of the protected activity; (3) the

employee suffered an unfavorable personnel action; and

(4) the circumstances raise an inference that the

protected activity was a contributing factor in the

personne! action. 29 C.F.R. § 1980.104(b)(1) (2007).

To satisfy the first element and establish that he

engaged in protected activity, an employee must show

that he had both "a subjective belief and an objectively

reasonable belief that the conduct he complained of

constituted a violation of relevant law. Livingston, 520

F.3d at 352. Additionally, an employee must show that

his communications to his employer "definitively and

specifically relate{d]" to one of the laws listed in §

1514A. Platone v. FLYi, Inc., ARB Case No. 04-154,

2006 DOLSOX LEXIS 105 at *83 (ARB Sept. 29, 2006)

(internal quotation marks omitted). The ARB held that

Welch failed to make out a prima facie case because he

did not establish that he had engaged in protected

activity; the ARB did not make any determination as to

the other three elements necessary for a prima facie

case.

Under the Administrative Procedure Act, 5 U.S.C. §

706(2)(A) (2006) -- which governs our review here, see

49 U.S.C. § 42121(b)(4)(A) -- we may only disturb the

ARB's decision if it was "arbitrary, capricious, an abuse

of discretion, or otherwise not in accordance with law."

We review questions of law de novo, giving deference

to the ARB's interpretation of § 1514A. See Chevron

U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S.

837, 843-44, 104 S. Ct. 2778, 81 L. Ed. 2d 694 (1984)* On

questions of fact, we will uphold the ARB's findings if

supported by substantial evidence. See Know v. U.S.

Dep't of Labor, 434 F.3d 721, 723-24 (4th Cir. 2006).

IIf.

Before turning to the central dispute here -- whether

the ARB erred in holding that Welch had failed to

establish that his communications constituted protected

activity under § 1514A -- we briefly address contentions

made by the parties as to the standard for establishing

protected activity.

Cardinal initially argues that Livingston holds that the

Sarbanes-Oxley Act only protects communications

relating to material violations of a listed law. As

Cardinal itself concedes, however, in Livingston, we

merely noted that a statement or omission must

concern a material fact to violate § 10(b) of the

Securities Exchange Act and SEC Rule 10b-5. 520 F.3d

at 355. Although many of the laws listed in § 1514A of

the Sarbanes-Oxley Act contain materiality

requirements, nothing in § 1514A (nor in Livingston)

indicates that § 1514A contains an independent

materiality requirement.’

The parties' remaining contentions involve the ARB's

interpretation of § 1514A to require that an employee's

communications to his employer “definitively and

specifically relate" to one of the listed laws for these

communications to constitute protected activity. See,

e.g., Platone, ARB Case No. 04-154, 2006 DOLSOX

LEXIS 105 at *34 (internal quotation marks omitted).

This requirement ensures that an employee's

communications to his employer are factually specific.

An employee need not "cite a code section he believes

was violated" in his communications to his employer,

but the employee's communications must identify the

specific conduct that the employee believes to be illegal.

13a

Fraser v. Fiduciary Trust Co. Int'l, 417 F. Supp. 2d

310, 322 (S.D.N.Y. 2006); see also Bechtel Constr. Co. v.

Sec'y of Labor, 50 F.8d 926, 981 (11th Cir. 1995)

(considering standard for protected activity under the

whistleblower provisions of the Energy Reorganization

Act, 42 U.S.C. § 5851). "[Gleneral inquiries do not

constitute protected activity." Fraser, 417 F. Supp. 2d

at 322 (internal quotation marks, omissions, and

citations omitted).

Welch maintains that by requiring his communications

to "definitively and specifically relate" to a listed law,

the ARB has interpreted § 1514A to require that an

employee complain of an actual violation of a listed law

in order to engage in protected activity, and that such a

requirement contradicts the text of the statute, which

provides that an employee who complains of conduct

that he "reasonably believes" violates a listed law

engages in protected activity. 18 U.S.C. § 1514A(a)(1).

We agree that such a requirement would contradict the

text of § 1514A, but the "definitively and specifically"

language does not in fact require that an employee

complain of an actual violation. Indeed, the ARB has

squarely held that § 1514A protects an employee's

communications based on a reasonable, but mistaken,

belief that conduct constitutes a securities violation. See

Halloum v. Intel Corp., ARB Case No. 04-068, 2006

DOLSOX LEXIS 5, slip op. at 6 (ARB Jan. 31, 2006);

accord Allen, 514 F.3d at 477.

Cardinal also misreads the "definitively and specifically"

language, though in a different manner. Cardinal

contends that the "definitively and_ specifically"

language imposes a heightened pleading standard in

Sarbanes-Oxley whistleblower cases. The ARB,

14a

however, has held that, for the requirement that an

employee's communications "definitively and

specifically relate" to a listed law, the "relevant inquiry"

is what an employee “actually communicated to [his]

employer prior to the .. . termination"; it is "not what

fis] alleged in [the employee's] OSHA complaint."

Platone, ARB Case No. 04-154, 2006 DOLSOX LEXIS

105 at *34-35 (emphasis added). Thus, contrary to

Cardinal's assertions, the "definitively and specifically"

language clearly does not impose a heightened pleading

standard in Sarbanes-Oxley whistleblower cases.

Accordingly, we turn to the central issue in this case --

whether Welch established that his communications

constituted activity protected by § 1514A.

iV.

The ARB held that Welch had failed to establish that

any of his communications constituted protected

activity under § 1514A of the Sarbanes-Oxley Act. The

ARB offered two rationales for its holding; both relate

to the requirement that Welch have an objectively

reasonable belief that the challenged conduct violated

relevant law. Although we must reject the first

rationale, we find no error in the second.

The ARB initially held, as a matter of law, that Welch

could not have had an objectively reasonable belief that

reporting the $ 195,000 in recovered loans as income

violated relevant law.‘ The ARB reasoned that even if

Cardinal erroneously reported the $ 195,000 as income

instead of recording it in the loan reserve account, the

15a

erroneous entries still showed that "Cardinal had in fact

recovered $ 195,000 that it previously did not have," and

that therefore Welch could not have had an objectively

reasonable belief that the loan entries might mislead

investors.

The ARB suggested that the misclassification of items

in a financial statement can never "present{] potential

investors with a misleading picture of [a company's]

financial condition," so long as the misclassification does

not affect the "bottom line.” We disagree. As the SEC

has explained in its amicus brief, "[t]he individual

items, subtotals, or other parts of a financial statement

may often be more useful than the aggregate to those

who make investment, credit, and similar decisions."

Statement of the SEC, Amicus Curiae, in Support of

Neither Side at 3 (quoting the Financial Accounting

Standards Board, Statement of Financial Accounting

Concepts No. 5, Recognition and Measurement of

Financial Statements of Business Enterprises 15-16,

Par. 22 (Dec. 1984)) (emphasis omitted). Thus, as the

Department of Labor now concedes, communications

about misclassifications in financial statements may, in

some circumstances, form the basis for a Sarbanes-

Oxa:cy -vhistleblower action, and the ARB erred to the

extent that it held to the contrary. Were this the only

rationale for the ARB's holding, we would have to

remand to allow the ARB to deterrnine whether Welch

could have reasonadly believed’ that __ this

misclassification violated relevant law.

The ARB offered a second rationale for its dismissal of

Welch's complaint, however. The ARB held that even if

l6a

Welch's charges proved correct -- that Cardinal

reported the $ 195,000 as income in violation of GAAP,

that Cardinal improperly restricted Welch's access to

Larrowe & Co., and that Moore permitted individuals

without expertise to make ledger entries -- Welch had

nonetheless failed to explain to the ARB how he could

have had an objectively reasonable belief that these

actions violated any of the laws listed in § 1514A.

After the ALJ ruled in favor of Welch, Cardinal filed a

petition for review with the ARB, taking exception to

the ALJ's findings of fact and conclusions of law,

pursuant to 29 C.F.R. § 1980.110 (2007). Cardinal

specifically took issue with the ALJ's rulings that

Welch had an objectively reasonable belief that his

communications identified violations of federal

securities laws. See Resp't's Pet. for Review at Pars. 2,

4,5 (Feb. 25, 2005). Cardinal argued that:

The ALJ erred in finding protected activity

because Welch's complaints .. . dic not allege

conduct that constituted a violation of, or even a

reasonably perceived violation of, federal

securities laws. Conspicuously absent from the

ALJ's analysis is any explanation of how the

conduct Welch complained about constituted a

violation of federal securities laws.

Br. of Resp't at 11, Welch v. Cardinal Bankshares

Corp., ARB Case No. 05-064 (ARB May 31, 2007).

Cardinal stressed that the ALJ had cited "no authority"

to support the proposition that the identified conduct

violated federal securities laws. Jd. at 18; see also id. at

16 (asserting that Welch's communications "did not

allege a violation of federal securities law" and that

17a

"(t]he ALJ fails to point to a single statute, regulation,

or case" in support of his holding).

In his response before the ARB, Welch defended the

ALJ's holding, but, like the ALJ, he utterly failed to

explain how Cardinal's alleged conduct could

reasonably be regarded as violating any of the laws

listed in § 1514A. Although Welch advanced several

arguments before the ARB, he supported these

arguments only with irrelevant and _ inapposite

authority or conclusory, general statements. ARB

therefore held that Welch had failed to establish that he

engaged in protected activity. We find no error in this

ruling. See, e.g., Hall v. U.S. Dep't of Labor, Admin.

Review Bd, 476 F.3d 847, 861 n.8 (10th Cir. 2007)

(explaining that the ARB is not required to "swa sponte

raise legal theories referenced only obliquely by a party

but not clearly articulated in its briefs"); cf. Fed. R.

App. P. 28¢b), (a)(9)(A) (requiring the appellee's brief to

contain an argument, which must, in turn, include

"citations to the authorities and parts of the record on

which [that party] relies").

To the extent that Welch now explains his position and

cites to relevant authority in his filings before this

court, he attempts to raise new arguments relying on

newly identified authorities. Welch has forfeited these

new arguments by failing to raise them before the

ARB. See, e.g., Taylor v. U.S. Dep't of Labor, 440 F.3d

1, 8-9 (1st Cir. 2005).

Of course, we do not suggest that a whistleblower must

identify specific statutory provisions or regulations

when complaining of conduct to an employer, nor do we

address the burden upon the parties in the proceedings

18a

before the ALJ. See 29 C.F.R. $§ 1980.103-109 (2007).

We simply hold that Welch completely failed to raise

any relevant arguments before the ARB and may not

now raise new arguments before this court.

For the reasons set forth above, the judgment of the

Administrative Review Board is

AFFIRMED.

Footr otes

lAdditionally, in October 2001, Welch sent a

memorandum to Moore advising that he had done

"some research on the internet" concerning insider

trading and that "[Moore's] personal trades and some of

[Moore's] friends' trades" were "questionable." Welch

testified that he later filed a complaint with the SEC

accusing Moore of insider trading, but the SEC did not

take any action on the coinplaint. Welch does not

pursue any asserted insider trading violations on

appeal.

2The Supreme Court has recognized that Chevron

deference is appropriate when it appears from the

“statutory circumstances that Congress would expect

the agency to be able to speak with the force of law."

United States v. Mead Corp., 533 U.S.-218, 229, 121 S.

Ct. 2164, 150 L. Ed. 2d 292 (2001). The Court has

instructed that "[iJt is fair to assume generally that

Congress contemplates administrative action with the

etfect of law when it provides for a relatively formal

administrative procedure" such as formal! adjudication.

19a

Id. at 230 & n.12. Congress explicitly delegated to the

Secretary of Labor authority to enforce § 1514A by

formal adjudication, see 18 U.S.C. § 1514A(b), and the

Secretary has delegated her enforcement authority to

the ARB, see 67 Fed. Reg. 64,272, 64,273 (Oct. 17, 2002).

Thus, we afford deference to the ARB's interpretation

of § 1514A of the Sarbanes-Oxley Act. Welch does not

argue to the contrary.

3Relying on dicta in Livingston, 520 F.3d at 351 & n.1,

Cardinal also contends that § 1514A only protects

communications concerning violations of SEC rules or

regulations that "relate to fraud” and that the asserted

violations raised by Welch do “not relate to fraud."

Welch counters that we did not so hold in Livingston,

and would not so hold now if squarely presented with

the question, see, e.g., O'Mahony v. Accenture Ltd., 537

F. Supp. 2d 506, 516-17 (S.D.N.Y. 2008), and that in any

event his communications do relate to fraud. We need

not resolve this question here, however, because, as

discussed below, Welch failed to explain to the ARB

how he could have had an objectively reasonable belief

that Cardinal violated any potentially relevant law,

whether or not it related to fraud.

4In order for an employee to prove that he engaged in

protected activity, he must show that he possessed both

a subjective belief and an objectively reasonable belief

that the conduct complained of constituted a violation of

relevant law. Livingston, 520 F.3d at 352; Melendez v.

Exxon Chems. Ams., ARB Case No. 96-051, slip op. at

25-29 (ARB July 14, 2000). Thus, the employee must

show both that he actually believed the conduct

complained of constituted a violation of pertinent law

and that "a reasonable person in his position would have

20a

believed that the conduct constituted a violation."

Livingston, 520 F.3d at 352; accord Allen, 514 F.3d at

ATT.

Welch argues that the ARB erroneously held that

objective reasonableness is always a question of law.

We agree that the ARB would have erred if it had so

held, because objective reasonableness is a mixed

question of law and fact. But the ARB did not hold that

objective reasonableness is always a question of law.

Rather, the ARB decided the question of objective

reasonableness as a matter of law in this case, as we did

in Jordan v. Alternative Resources Corp., 458 F.3d 332,

340-41 (4th Cir. 2006). As in Jordan, the ARB applied

the familiar rule that issues may be decided as a matter

of law if the facts cannot support a verdict for the non-

moving party. Accord Livingston, 520 F.3d at 353-56;

Allen, 514 F.3d at 477-78.

5For example, before the ARB, to support his

contentions regarding the $ 195,000 in recovered loans

in the 2001 third-quarter 10-QSB report, Welch relied

on laws and regulations passed years after the filing of

that report, as well as other regulations which clearly

do not fall within the purview of § 1514A. He also cited

to general accounting standards and the general

purpose of the securities laws. He did not explain -- as

he attempts to on appeal -- how a person could

reasonably believe that the failure to correct the 10-

QSB report might violate any relevant federal law or

applicable SEC regulation. Similarly, with regard to

Cardinal's practice of allowing individuals without

accounting expertise to make ledger entries, before the

ARB, Welch cited accounting treatises and insisted

that the practice "violatled]| the intent of the SEC rules

Z2la

and regulations," but he never explained how a person

could have an objectively reasonable belief that this

conduct violated any of the laws listed in § 1514A.

22a

ARB CASE NO. 05-064

ALJ CASE NO. 2003-SOX-15

DATE: May 31, 2007

In the Matter of:

DAVID WELCH,

COMPLAINANT,

Vv.

CARDINAL BANKSHARES CORPORATION,

RESPONDENT.

BEFORE: THE ADMINISTRATIVE REVIEW

Board

Appearances:

For the Complainant:

D. Bruce Shine, Esq., Donald F. Mason, Shine &

Mason, Kingsport, Tennessee

For the Respondent:

Laura Effel, Esq., Douglas W. Densmore, Esq.,

Joseph M. Rainsbury, Esq., Leclair, Ryan Flippin

Densmore, Roanoke, Virginia; Betty Southard Murphy,

Esq., Mare A. Antonetti, Esq., Baker & Hostetler LLP,

Washington, D.C.

For Amicus Curiae American Ass'n of Bank Directors:

Arthur P. Strickland, Esq., Roanoke, Virginia

23a

For Amici Curiae Virginia Bankers Ass'n and

Virginia Ass'n of Community Banks:

Joseph E. Spruill, III, Esq., G. Andrew Nea, Jr.,

Williams Mullen, Richmond, Virginia

For Amicus Curiae American Bankers’ Ass'n:

C. Dawn Causey, General Counsel, Gregory F.

Taylor, Assoc. General Counsel, Washington, D.C.

FINAL DECISION AND ORDER

David E. Welch filed a complaint with the United

States Department of Labor in which he alleged that

Cardinal Bankshares Corp. (Cardinal) violated the

employee protection provision of the Sarbanes-Oxley

Act of 2002 (SOX)! when it terminated his employment

on October 1, 2002. After a hearing, an Administrative

Law Judge (ALJ) concluded that Cardinal had violated

the SOX and recommended that Welch be reinstated

and receive back pay and other relief. But because the

ALJ committed legal error, we will not adopt his

recommendation, and we deny Welch's complaint.

BACKGROUND

Cardinal is a publicly-traded bank holding company

subject to the SOX's employee protection section.

Cardinal, which was established in 1996, is the sole

owner of Bank of Floyd and its branch offices located in

and near Floyd, Virginia. Cardinal and the bank share

office facilities, employees, and executive staff.*

Transcript (T) 29.

Ronald Leon Moore, who had been working for the

bank since 1988, helped create the holding company and

24a

subsequently served as Cardinal's Chief Executive

Officer, member and chairman of Cardinal's Board of

Directors, and member of the Board's Audit

Committee. Moore hired Welch as a _ part-time

accounting officer in February 1999. About a year later,

Welch asked for a full-time position as Cardinal's Chief

Financial Officer, and Moore agreed. Welch is a

certified public accountant and holds a masters degree

in business administration. As CFO, Welch's essential

duties included preparing federal, state, and local

financial reports of various’ kinds; developing

accounting control procedures; and reviewing and

correcting "errors and inconsistencies in financial

entries, documents, and reports." Complainant's

Exhibit (CX) 35; T 245-246, 357.

The financial records and reports Welch produced

included quarterly "call reports" to state bank

examiners and the Federal Reserve Board and

quarterly (Form 10-QSB) and annual (Form 10-K)

reports to the Securities and Exchange Commission

(SEC). The SEC reports contain financial information

such as a statement of operations, income statement,

balance sheet, statement of cash flows, and changes in

capital based on shares bought and sold, as well as

company commentary. A _ local accounting firm,

Larrowe & Co., provided Cardinal with independent

audits for the quarterly reports. T 42.

Welch based the reports he produced on Cardinal's

"general ledgers," or "journals," where Welch and others

recorded all financial transactions. Cardinal required

that a witness countersign each ledger entry and that

the CFO review all entries every month. Thus, every

month Welch reviewed the ledger for errors and either

25a

made corrections himself or recommended corrections

to Moore. CX 23.

Welch testified that he believed that Cardinal

violated ‘ generally accepted accounting practices

(GAAP) because Cardinal allowed people with no

special accounting skills to make ledger entries. Under

GAAP standards, only persons with accounting

expertise should be permitted to make ledger entries.

In fact, Welch testified that he wanted all but routine

entries to be cleared with him in advance. CX 23; T 61.

Moore, who often made ledger entries himself or

directed others to make entries, would not agree to

limit access to the ledger or to turn over ledger entry

control to Welch. And on occasion, Moore refused to

make corrections Welch thought should be made.

In the second and third quarters of 2001, Moore

recorded two loan recoveries as forms of income

($45,000 in June 2001, and $150,000 in July 2001) on

accounts Cardinal had _ previously written off.

Consequently, Cardinal's third-quarter 10-QSB report

to the SEC included this $195,000 in year-to-date

income.’ Welch discovered the entries during his

September ledger review and told Moore that GAAP

standards do not permit loan recoveries to be treated as

income. Instead, they must be accounted for in the “loan

reserve" account.’ In the last quarter of 2001, Welch

told Moore that the misclassification caused Cardinal's

third quarter SEC report to overstate Cardinal's year-

to-date income. Later, when Larrowe & Co. audited

Cardinal's annual SEC report for 2001, Welch pointed

out the error to Beth Worrell, the auditor in charge,

and she corrected the accounting according to Welch's

recommendation. CX 12; CX 23; T 49, 52-55.

26a

Welch had other concerns besides the loan recoveries.

Moore repeatedly rejected Welch's accounting advice,

and Welch felt excluded from discussions between

Moore and Larrowe & Co. about accounting issues. In

October 2001, Welch sent Moore a memo in which he

formally accused Moore of insider trading. And in

March 2002, Welch filed a complaint with the SEC

accusing Moore of insider trading. In June 2002, when

Cardinal agreed to merge with MountainBank

Financial Corporation, Welch feared that his job would

be eliminated. Then, in July, Wanda Gardner,

Cardinal's internal auditor, reported to the Board of

Directors that Welch's system for retrieving wire

transfer information was severely flawed. In August,

state bank examiners found over a dozen errors in one

of Welch's call reports. CX 6; CX 8; CX 24; T 38-30, 57,

110-111, 116. During the state banking review, Welch

emailed one of the examiners that he, Welch, had

information about "things that have gone on at the bank

that I do not think are on the up and up." But neither

the SEC nor the state bank examiners showed any

interest in Welch's claims. CX 13; CX 14 p. 2; T 137-130,

156. Welch did not take any of these concerns to

Cardinal's Board of Directors or its Audit Committee

because he was afraid that Moore would fire him for

doing so. T 125, 140.

Welch wrote Larrowe & Co.'s Worrell on August 2,

2002, that he would not be signing a "representation

letter" she had prepared for his signature. The

representation letter was a statement attesting to the

accuracy, reliability, and completeness of the financial

data that Cardinal was providing to Larrowe & Co.

Welch was concerned that unqualified persons were

making ledger entries, and he told Worrell that he

27a

could not sign the representation letter because "over

the past year to year and a half, I have been excluded

from your [Larrowe & Co. and Moore] communications

loop almost entirely." CX 17.

Two weeks later, Welch notified Moore by memo

about these same concerns and therefore would not

certify Cardinal's next 10-QSB report either. CX 20. A

month later, Welch followed up with a more detailed

memo to Moore, elaborating on his opinion that in its

2001 third-quarter 10-QSB Cardinal had overstated its

year-to-date income by $195,000 and should file a

corrected report, complained that he was being

excluded from the process of designing disclosure

controls and procedures as the SOX _ required,

complained that he was not permitted to address the

Audit Committee or the Board of Directors, and

reiterated his views that people without accounting

expertise should not be making ledger entries and that

Moore had engaged in insider trading. T 109, 119-120;

CX 1.

Moore called a special meeting of the Board on

September 17, 2002, in which he read Welch's memo

and described various ways that Welch's performance

as CFO had been unsatisfactory. Douglas Densmore,

counsel to the Board and the Audit Committee,

recommended that the Audit Committee investigate

Welch's charges and that Cardinal discuss the situation

with banking regulators and MountainBank Financial

Corp. Venson Bolt, Chairman of the Audit Committee,

asked Michael Larrowe and Densmore to investigate

Welch's charges and report their findings in writing.

Joint Exhibit (JX) 1.

28a

Meanwhile, Welch scheduled a Sarbanes-Oxley

"Briefing" for Cardinal managers on September 20 and

consulted with an attorney on how best to make his

presentation. According to an outline he prepared,

Welch planned to tell the attendees that some of

Cardinal's accounting practices were illegal, including

treating loan recoveries as income, excluding him from

Moore's consultations with Larrowe & Co., and

allowing persons without accounting expertise to make

entries to the general ledger. JX 2; CX 26;

Respondent's Exhibit (RX) 1; T 74-81.

He then planned to excuse everyone except Fred

Newhouse, the Executive Vice President, and Marie

Thomas, head of Human Resources. To Newhouse and

Thomas, Welch would present the terms of a

retirement package he wanted in exchange for leaving

the bank “without saying anything to anyone" about

accounting problems at Cardinal. He wanted a salary

payment of more than one week for each year of

service, the remainder of his 2001 performance bonus,

full vesting of his retirement, including all of the Bank

of Floyd's’ contributions, and a _ letter’ of

recommendation. JX 2; T 144-153; RX 1.

The group convened on the 20th. Welch began by

turning on a tape recorder, and when Moore asked him

to turn it off, Welch refused. After explaining to the

group that he had been consulting with a lawyer, Welch

announced, "I tell you there's three people in this room

that are parties to fraudulent acts... ." At that point,

Moore and Battle left the meeting, and Welch continued

as planned. JX 2; T 148-152.

29a

The following week, when Densmore and Larrowe

tried to interview Welch and to get a copy of the

September 20 tape recording, Welch told them he did

not have the tape and had not been able to consult with

his attorney since the September 20 meeting. JX 6, 8, 9,

10, 11. But he told them that he had an appointment

with his attorney on the following day, and would then

decide how to proceed. . X 6.

When Densmore and Larrowe reported to Bolt that

Welch was not willing to be interviewed because his

attorney was out of town, Bolt suspended Welch with

pay pending the outcome of the investigation. "We

consider your refusal to meet with counsel and outside

auditors to discuss matters within your area of

responsibility a serious breach of your legal obligations

to the company and its Board of Directors." JX 11.

After consulting his lawyer and scheduling a meeting

with Densmore and Larrowe for September 30, Welch

notified Densmore that he would not meet with him and

Larrowe after all and would not meet with the audit

committee unless he could bring his attorney. And

Welch's attorney, writing to Densmore, stated that "[iJf

it is your intent not to allow me to represent Mr. Welch

in front of the Committee, please let me know so we can

cancel the meeting." JX 18.8

The meeting was cancelled, and on October 1, 2002,

Densmore and Larrowe presented their findings to

members of the Board and the Audit Committee.

Densmore and Larrowe concluded that the available

information material in Larrowe & Co. files, Welch's

memos and letters to Moore, Worrell, and others, and

statements from various Cardinal employees’ did not

30a

support Welch's allegations. Densmore and Larrowe

told the Board that if Welch really thought that

Cardinal's accounting practices were deficient to the

point of illegaiity, ae had a fiduciary duty not only to

tell the Board or the Audit Committee, but to cooperate

- unconditionally in the Committee's efforts to

investigate his charges. Densmore and Larrowe

recommended that the Board terminate Welch's

employment immediately. By unanimous vote, the

Board converted Welch's suspension into a termination

effective October 1. JX 19, 20, 21, 22.

Welch then filed this whistleblower complaint. After

an investigation, the Occupational Safety and Health

Administration (OSHA), the Labor Department agency

charged with investigating SOX whistleblower

complaints, concluded that Welch's complaint had no

merit. Welch requested a hearing before a Labor

Department ALJ. As already noted, the ALJ concluded

that Cardinal violated the SOX and recommended that

Welch be reinstated and receive back pay and other

forms of relief. Cardinal appealed.

JURISDICTION AND STANDARD OF REVIEW

The Secretary of Labor has delegated her authority

to issue final agency decisions under the SOX to the

Administrative Review Board.* Pursuant to the SOX

and its implementing regulations, the Board reviews

the ALJ's fact findings under the substantial evidence

standard.? Substantial evidence is that which is "more

than a mere scintilla. It means such relevant evidence

as a reasonable mind might accept as adequate to

Support a conclusion."§ We must uphold an ALJ's

factual .inding that is supported by _ substantial

sla

evidence even if there is also substantial evidence for

the other party and even if we "would justifiably have

made a different choice had the matter been before us

de novo."”

In reviewing the ALJ's conclusions of law, the Board,

as the Secretary's designee, acis with "all the powers

{the Secretary] would have in making the initial

decision .. . ."° Therefore, the Board reviews an ALJ's

conclusions of law de novo.

Discussion

1. The Legal Standard

The employee protection provision of the SOX

prohibits employers from retaliating against employees

for providing information or assisting in investigations

related to securities fraud:

(a) Whistleblower protection for employees of publicly

traded companies.--No company with a class of

securities registered under section 12 of the Securities

Exchange Act of 1934 (15 U.S.C. 781), or that is

required to file reports under section 15(d) of the

Securities Exchange Act of 1934 (15 U.S.C. 780(d)), or

any officer, employee, contractor, subcontractor, or

agent of such company, may discharge, demote,

suspend, threaten, harass, or in any other manner

discriminate against an employee in the terms and

conditions of employment because of any lawful act

done by the employee--

(1) to provide information, cause information to be

provided, or otherwise assist in an investigation

32a

regarding any conduct which the employee reasonably

believes constitutes a violation of section 1341, 1348,

1344, or 1348, any rule or regulation of the Securities

and Exchange Commission, or any provision of Federal

law relating to fraud against shareholders, when the

information or assistance is provided to or the

investigation is conducted by--

(A) a Federal regulatory or law enforcement agency;

(B) any Member of Congress or any committee of

Congress; or

employee (or such other person working for the

employer who has the authority to investigate,

discover, or terminate misconduct); or

(2) to file, cause to be filed, testify, participate in, or

otherwise assist in a proceeding filed or about to be

filed (with any knowledge of the employer) relating to

an alleged violation of section 1341, 1348, 1344, or 1348,

any rule or regulation of the Securities and Exchange

Commission, or any provision of Federal law relating to

fraud against shareholders.”

To prevail, Welch must prove by a preponderance of

the evidence that: (1) he engaged in a protected activity

or conduct; (2) Cardinal knew that he engaged in the

protected activity; (3) Welch suffered an unfavorable

personnel action; and (4) the protected activity was a

contributing factor in the unfavorable action.#

With respect to the protected activity requirement,

Welch must prove by a preponderance of the evidence

33a

that he provided information to Cardinal that he

reasonably believed constituted a violation of 18

U.S.C.A., sections 1341 (mail fraud), 1343 (wire, radio,

TV fraud), 1344 (bank fraud), or 1348 (securities fraud),

or any rule or regulation of the Securities and

Exchange Commission (SEC), or any provision of

Federal law relating to fraud against shareholders.“

Under the SOX, the employee's communications must

"definitively and specifically” relate to any of the listed

federal securities laws.”

Welch claimed that he engaged in five protected

activities. The ALJ concluded that Welch engaged in

three and made no findings as to the other two.

Recommended Decision and Order (R. D. & O.) at 53-

54. Welch has not objected so we limit our decision to

the three activities that the ALJ addressed.

2. Welch Did Not Engage in SOX-Protected Activity

A. The $195,000 Loan Recovery Entries

The ALJ found that in September 2001 Welch told

Moore that the loan recoveries should not be classified

as income. He concluded that Welch reasonably

believed that entering the loan recoveries as income

was "improper" because Welch testified, and Cardinal

did not dispute, that instructions for preparing a

Federal Reserve call report, a form similar to the SEC

10-QSB, required that loan recoveries be reported in

the “allowance account" (i.e., the loan reserve account),

not in the income account. Moreover, he found that

when Larrowe & Co. corrected these entries in tts 2001

annual report to the SEC, Welch's concern that loan

34a

recoveries should not have been entered as income was

confirmed. R. D. & O. at 55.

Because the errors in the general ledger were

reflected in its 2001 third-quarter 10-QSB report to the

SEC, the ALJ found that Cardinal publicly overstated

its year-to-date income By $195,000. Jd. at 56. Thus, he

concluded that Welch reasonably believed that the 2001

third-quarter 10-QSB could mislead potential investors

because it materially overstated Cardinal's finoncial

status. In reaching this conclusion, the ALJ cited

Welch's calculation that including the loan recoveries in

the income column of the report improperly inflated

Cardinal third-quarter income by 13.7%. He also noted

Welch's testimony that a 21% increase in Cardinal stock

prices between September 6, 2001, and October 18,

2001, had convinced him that the overstated income

"made Cardinal look like it was performing really better

than it was." Jd. at 54.46

The ALJ rejected Cardinal's argument that because

Welch had previously signed financial statements and

call reports without objecting to the entries, he could

not have reasonably believed that the ledger entries

were improper. The ALJ found that Welch convincingly

explained that he had not previously objected because,

unlike the SEC report, the financial statements and call

reports were not public documents that investors would

see and rely upon. Welch also testified that, at the time,

he still thought he could persuade Moore to change the

financial statements. Furthermore, Welch explained,

when the SOX became effective, he could be sanctioned

for false certifications, and the new whistleblower

provision would protect his employment. R. D. & O. at

a7.

35a

Michael Larrowe testified that the third quarter SEC

report did not misrepresent Cardinal's financial

condition. Larrowe testified that, yes, the result of the

journal entries was an overstatement of income on the

third quarter SEC report, but the understated loan

reserve account offset the income overstatement.

Therefore, according to Larrowe, the report gave a fair

picture of Cardinal's financial condition the company

had $195,000 more at the end of the third quarter than

it had before it recovered the two loans. But the ALJ

was "more persuaded" by Welch's testimony than

Larrowe's because he found certain portions of

Larrowe's testimony to be contradictory. /d. at 55-57.

Cardinal argues to us that Welch did not have a

reasonable basis for believing that it overstated its net

income. Br. at 11. To support this argument, Cardinal

contends that even if the original decision to enter the

loan recoveries as income in the general ledger was an

accounting mistake, it does not follow that the SEC

report overstated income to date. "In 2001, Cardinal

collected certain bad debt in the amount of $195,000. It

did not, as it should have, credit[ed] the allowance and

then enter[ed] negative entries in the expense line item

for provision.’ Rather, it classified the $195,000 as

forms of income. However, an entry adding $195,000 to

income has exactly the same effect on the bottom line as

an entry subtracting $195,000 from expenses: they both

increase it by $195,000." Br. at 18. "What Welch and

the ALJ repeatedly fail to recognize is that, with these

$195,000 recoveries on previously written-off accounts,

real money came into Cardinal's door money that

was not there before." Rebuttal Br. at 3 (emphasis in

original). "A reasonable CPA and CFO could not have

36a

concluded that there was an overstatement of net

income." 7d.

Cardinal also argues that the ALJ erred in concluding

that Welch engaged in protected activity "because

Welch's complaints even if well founded (which they

were not) did not allege conduct that constituted a

violation of, or even a reasonably perceived violation of

federal securities laws. Conspicuously absent from the

ALJ's analysis is any explanation of how the conduct

complained about constituted a violation of federal

securities laws." Br. at 11.

Welch Could Not Have Reasonably Believed That

Cardinal Misstated Its Financial Condition

We hold that the ALJ erred as a matter of law in

concluding that Welch's concerns about the loan

recovery entries and the subsequent third quarter SEC

report were protected. As previously noted, the SOX

protects employees who report conduct which the

employee reasonably believes constitutes a violation of

the specified federal securities laws. The "reasonable

belief" standard requires Welch to prove both that he

actually believed that the SEC report overstated

income and that a person with his expertise and

knowledge would have reasonably believed that as

well Furthermore, “[bJecause the analysis for

determining whether an employee reasonably believes

a practice is uniawful is an objective one, the issue may

be resolved as a matter of law."48

Although the ALJ did not expressly distinguish

between Welch's” subjective belief and what a

CPA/CFO in Welch's position would reasonably

37a

believe, his opinion’ implicitly makes both

determinations because he wrote, "The standard for

determining whether Complainant's belief is reasonable

involves an objective assessment." R. D. & O. at 58.

Nevertheless, we conclude that the ALJ erred as a

matter of law when he determined that Welch

reasonably believed that Cardinal violated the federal

securities laws by reporting inflated income in the 2001

third-quarter SEC report. After all, whether or not

Cardinal misclassified the loan recoveries as income

rather than crediting the loan reserve account, and

whether or not stock prices increased 21% between

September 2001 and October 2001, and whether or not

Larrowe & Co. properly classified the loan recoveries

for Cardinal's year-end 2001 SEC report, Cardinal had

in fact recovered $195,000 that it previously did not

have. Therefore, an experienced CPA/CFO like Welch

could not have reasonably believed that the third

quarter SEC report presented potential investors with

a misleading picture of Cardinal's financial condition.

Thus, because the "reasonable belief" test is a matter of

law, the ALJ's conclusion about Welch's reasonable

belief constitutes legal error.”

Welch's Argument About Accounting Standards

On this appeal, Welch, of course, urges us to affirm

the ALJ's relevant findings and conclusions concerning

his protected activity. But he also contends that when

Cardinal misclassified the loan recoveries as income

rather than crediting the loan loss account, it violated

GAAP accounting standards and accounting rules that

the Federal Financial Institutions Examination Council

(FFIEC) developed for banks.22 Welch cites a SOX

33a

provision that directs the Public Company Accounting

Oversight Board ("Oversight Board") to adopt rules and

other standards that require public accounting firms to

evaluate whether covered companies’ "provide

reasonable assurance that transactions are recorded as

necessary to permit preparation of financial statements

in accordance with generally accepted accounting

principles." Br. at 8, 9 Welch then writes that he

"sought at all times material to assure that GAAS

[generally accepted accounting standards] and GAAP

standards were adhered to by Cardinal in its financial

reports relied upon by the investing public. Those

accounting standards, when violated, also violate the

clear mandate of Sarbanes-Oxley." Jd. at 9. Thus, Welch

seems to argue that these accounting errors were ipso

facto violations of the federal securities laws because

these standards and the federal securities laws have

the same purpose _ protecting investors from financial

misrepresentations. Br. at 8-21.

But this argument amounts to wholesale re-writing of

SOX's section 1514A. That section clearly indicates that

Congress intended to protect whistleblowers who

report about specifically enumerated employer conduct

violations of the Federal fraud statutes, SEC rules or

regulations, or Federal laws relating to shareholder

fraud. According to Welch, Congress, without saying

so, must also have meant to extend protection to those

employees who report violations of GAAS, GAAP, or

FFIEC standards. But Welch has not supported this

argument with any authority. Therefore, we reject this

argument.

B. Welch's Complaints About Access to Larrowe &

Co. Are Not Protected

39a

Relying on Welch's testimony and his memos to

Worrell and Moore in August and September 2002, the

ALJ concluded that, "Complainant reasonably believed

Larrowe & Co. did not sufficiently communicate with

him regarding financial matters entrusted to him by his

job description but rather went directly to Moore and

around {Complainant]."" R. D. & O. at 57. Michael

Larrowe's testimony that Welch's complaints were due

to a "relationship problem" and Larrowe's investigation

report finding that Welch chose to play a lesser role

were “unconvincing” to the ALJ because Larrowe had

an interest in exonerating himself and his firm and had

given inconsistent explanations for his failure to tell the

Audit Committee that some of Welch's complaints were

directed at his own company. Jd. at 58. Furthermore,

Larrowe's own report acknowledged the possibility

that Welch's access had been restricted. /d. Therefore,

the ALJ concluded, Welch's complaints were protected

activity.

Cardinal argues that the ALJ erred in concluding that

complaints about insufficient access to outside auditors

are protected activity. "The ALJ fails to point to a

single statute, regulation, or case that holds that an

external auditor's preference for communicating with

that company's CEO rather than its CFO constitutes

securities fraud." Br. at 16. In fact, Cardinal asserts,

"(t]he role of the external] auditor is to review those

reports and submissions for accuracy. It acts as a

watchdog over information supplied by management. It

does not act as a'source of information to management."

Id. at 16-17.

Welch contends that, "[iJn failing to work with Welch

in providing him information to accomplish his function

40a

and comply with the Sarbanes-Oxley certification

program, Cardinal and Larrowe & Company defeated

the intent of the SEC and Congress that investment

decisions by the public be made and based upon

accurate and non-misleading financial statements.” Br.

at 22-23.

But Welch did not prove by a preponderance of

evidence how his unhappiness about access to Larrowe

& Co. coristituted a reasonable belief that Cardinal was

violating or might violate the enumerated fraud

statutes, any SEC rule or regulation, or any federal law

relating to fraud against shareholders. To be protected,

an employee's SOX complaint must definitively and

specifically relate to the listed categories of fraud or

securities violation. Therefore, the ALJ erred in

concluding that Welch's complaints about access to

Larrowe & Co. constituted protected activity because

he does not discuss or make a finding about how

insufficient access to Larrowe & Co. relates to the

federal securities laws.

C. Welch's Complaints About Inadequate Internal

Controls Are Not Protected

The ALJ found that the $195,000 accounting error and

Moore's practice of having his secretary, Annette

Battle, credit funds earned in one year to expenses

incurred in a different year "were part of a pattern that

suggested that Cardinal's internal controls were

deficient." R. D. & O. at 60. "I find it was reasonable for

Welch to believe that too many individuals without

financial expertise were making journal entries without

the CFO's review and that there were inadequate

internal financial controls." R. D. & O. at 59. Therefore,

Ala

the ALJ concluded that Welch engaged in protected

activity when he repeatedly reported that Cardinal's

internal controls were deficient because people without

accounting expertise had unrestricted access to the

general ledger.

Cardinal argues that even if Welch's complaints about

internal controls were valid, they do not constitute

protected activity because they do not implicate the

federal securities laws. Cardinal again points out that

the ALJ cited no authority to suppert his conclusion

that its deficient internal controls caused it to violate

the federal securities laws. "Although having a deficient

internal control may make an_ institution more

vulnerable to fraud, in itself it is not fraudulent." Br. at

18. We hold that the ALJ erred in concluding that

Welch's complaints to Moore about inadequate internal

controls constituted protected activity because, again,

the ALJ did not discuss how, or make a finding that, the

deficient internal control system related to the federal

securities laws.

Welch argues that the internal controls themselves

were not the problem. According to Welch, the

bookkeeping errors about which he _ complained

"occurred not because of a failure in the bank's internal

controls, but because those controls were disregarded

by Moore and resulted in the financial statements of

Cardinal to be unfairly presented." In his September 20

SOX briefing to Cardinal staff, Welch explained that

shareholders could be defrauded if his instructions were

ignored. "[I]f you do something that [I tell you] is

against the law, you're advised of it, and then you

refuse to make the correction, then that could be

construed as fraud. Because then it's not an accident or

42a

mistake, it becomes an intent to leave things in a

deceptive state." T 74-75. Thus, because Moore did not

heed his advice, Welch argues that Cardinal violated

"the second purpose of the SEC to prohibit deceit,

misrepresentations and other fraud in the sale of

securities.'" Br. at 27.

We reject Welch's argument that when he complained

about Moore's refusal to make the changes Welch

wanted, Moore intended to mislead investors. Welch

has given us no legal authority for the proposition that

rejecting the CFO's advice on accounting matters

violates or could reasonably be regarded as violating

the federal securities laws. Nor has he explained how

merely refusing to accept Welch's advice supports an

inference that Moore intended to deceive shareholders.

Conclusion

We reverse the ALJ's conclusion that Cardinal

violated the SOX because, as a matter of law, he erred

in concluding that Welch engaged in SOX-protected

activity. Welch's concerns that Cardinal misclassified

the loan recoveries and consequently misled investors

do not constitute protected activity because Welch

could not have reasonably believed that Cardinal

misstated its financial condition. Likewise, Welch's

complaints about access to Larrowe & Co. and about

Cardinal's internal accounting controls are not SOX-

protected activity because they do not relate to the

federal securities laws. Therefore, since Welch has not

demonstrated that he engaged in protected activity, an

essential element of his case, we DENY his complaint.

SO ORDERED.

43a

OLIVER M. TRANSUE

Administrative Appeals Judge

M. CYNTHIA DOUGLASS

Chief Administrative Appeals Judge

[ENDNOTES]

118 U.S.C.A. § 1514A (West Supp. 2005). Regulations

implementing the SOX are found at 29 C.F.R. Part 1980

(2006).

¢ Hereafter, we refer to Cardinal Bankshares and the

Bank of Floyd interchangeably as "Cardinal."

* Witnesses and the ALJ sometimes referred to the two

loan recoveries as if there had been a single recovery of

$195,000 during the third quarter of 2001. This is a

convenient shorthand description of what happened

because Welch complained about the fact’ that

Cardinal's third-quarter 10-QSB included the $195,000

in its year-to-date income.

4"Loan reserve accounts" are funds that a bank holds in

reserve to cover projected losses. United States v.

Whitmore, 35 Fed.Appx. 307, 314-315 (9th Cir. 2002).

2 Cardinal and amici Virginia Bankers Association,

Virginia Association of Community Banks, and

American Association of Bank Directors argue that the

ALJ committed error in holding that SOX section

1514A_ gives’ whistleblowers the right to be

accompanied by private counsel during internal

company investigations of their complaints and that the

attorney-client privilege would not have applied to

44a

Densmore and Larrowe's interviews of Welch.

Inasmuch as the ALJ did not purport to rule that

whistleblowers have a right to be accompanied by

counsel during internal investigations of their

complaints, he did not err. And because the privilege

issue is not implicated in our decision here, we need not

address the question whether the interviews would

have been privileged.

® Secretary's Order 1-2002 (Delegation of Authority and

Responsibility to the Administrative Review Board), 67

Fed. Reg. 64,272 (Oct. 17, 2002); 29 C.F.R. § 1980.110

(2007).

1 See 29 C.F.R. § 1980.110(b).

Clean Harbors Envtl. Servs., Inc. v. Herman, 146 F.3d

12, 21 (1st Cir. 1998), (quoting Richardson v. Perales,

402 U.S. 389, 401 (1971)).

2 Universal Camera Corp. v. NLRB, 340 U.S. 474, 488

(1951).

25 U.S.C.A. § 557(b) (West 1996).

ll See Getman v. Sw. Secs., Inc., ARB No. 04-059, ALJ

No. 2003-SOX-8, slip op. at 7 (ARB July 29, 2005).

12218 U.S.C.A. § 1514A(a).

13 See 49 U.S.C.A. § 42121(b)(2)(B) (iii) (West Supp.

2006). See also Getman, slip op. at 8; Peck v. Safe Air

Int'l, Inc. d/b/a Island Express, ARB No. 02-028, ALJ

No. 2001-AIR-3, slip op. at 6-10 (ARB Jan. 30, 2004).

45a

4 Hereinafter, we refer to these Federal statutes and

SEC rules and regulations, collectively, as the "federal

‘securities laws."

4 Platone v. FLYi, Inc., ARB No. 04-154, ALJ No.

2003-SO X-27, slip op. at 17 (ARB Sept. 29, 2006).

46 But as Cardinal points out, and the record supports,

since the third quarter 2001 report was not filed with

the SEC until November 14, 2001, the stock price spike

between September 6 and October 18 could not have

been the result of the SEC report. Rebuttal Br. at 4;

RX 6.

il Melendez v. Exxon Chems. Am., ARB No. 96-051,

ALJ No. 97-ERA-006, slip op. at 27-28 (ARB July 14,

2000)

Jordan v. Alternative Res. Corp., 458 F.3d 332, 339

(4th Cir. 2006), cert. denied, _ U.S. __, 127 S.Ct. 2036

(2007).

12 See Jordan, 458 F.. 3d. at 339.

“# The ALJ did not make findings whether Cardinai

violated GAAP or FFIEC standards.

42 15 U.S.C.A. § 7218(a)(2)(A)ai)UD(bb) (West Supp

2006). Oversight Board rules require independent

accountants of publicly traded companies to comply

with generally accepted auditing standards. But the

Oversight Board did not adopt these rules until 2003,

long after Cardinal fired Welch. See

ww.PCAOB.org/standards/interim-

standards/index.aspx.

46a

2 See Hall v. U.S. Dep't of Labor, ARB Nos. 02-108, 03-

013, ALJ No. 1997-SDW-005, slip op. at 6 (ARB Dec..30,

2004) (failure to present argument or pertinent

authority waives argument), aff'd, 476 F.3d 847, 861 n.8

("allegations unsupported by legal argument or citation

to evidentiary support in the record are insufficient to

raise the specific legal theory [appellant] now alleges

ARB overlooked"). Cf. 2A Sutherland on Statutory

Construction § 46:4 (N. Singer, 6th ed. 2000) ("A party

who asks the court to ignore the plain language of a

statute must show that it is manifest that the

legislature could not possibly have meant what it said in

that language, or the natural reading of the statute

would lead to an absurd result").

# Platone, slip op. at 17. See also Getman, slip op. 9-10.

47a

U.S. Department of Office of Administrative Law

Labor Judges

800 K Street, NW, Suite 400-N

Washington, DC 20001-8002

Issue Date: 28 January 2004

CASE NO.: 2003-SOX-15

In the Matter of:

DAVID E. WELCH,

Complainant,

Vv.

CARDINAL BANKSHARES CORPORATION,

Respondent.

APPEARANCES:

Bruce Shine, Attorney

For Complainant

Laura Effel, Attorney

Douglas W. Densmore, Attorney

Joseph M. Rainsbury, Attorney

For Respondent

48a

BEFORE:

Stephen L. Purcell

Administrative Law Judge

RECOMMENDED DECISION AND ORDER

This case arises under the whistleblower provisions

of Public Law 107-204, Section 806 of the Corporate and

Criminal Fraud Accountability Act of 2002, Title VIII

of the Sarbanes-Oxley Act of 2002, 18 U.S.C. §1514A

("Sarbanes-Oxley") enacted on July 30, 2002. This

statutory provision prohibits any company with a class

of securities registered under 812 of the Security

Exchange Act of 1934, or required to file reports under

§15(d) of the same Act, or any officer, employee, or

agent of such company, from discharging, harassing, or

in any other manner discriminating against an

employee in the terms and conditions of employment

because the employee provided to the employer or

Federal Government information relating to alleged

violations of 18 U.S.C. §$§1341, 1343, 1344 or 1348, any

rule or regulation of the Securities and Exchange

Commission [{"SEC"], or any provision of Federal law

relating to fraud against shareholders.

Procedural Background

David Welch, Complainant, filed an appeal with the

Office of Administrative Law Judges on April 29, 20038,

from a February 4, 2003 denial of his complaint by the

Occupational Safety and Health Administration, U.S.

Department of Labor.

49a

A formal hearing was originally scheduled to

commence June 25, 2003 at the United States District

Courthouse, Roanoke, Virginia. The hearing date was

later changed at the request of the parties to August

25, 2003, and the hearing took place as scheduled on

August 25th and 26th, 2003. All parties were afforded a

full opportunity to adduce_ testimony, offer

documentary evidence, submit oral arguments, and file

post-hearing briefs. The following exhibits were

admitted into evidence: Complainant's Exhibdits ("CX")

1-32, Joint Exhibits ("JX") 1-22, Respondent's Exhibit

("RX") 1-8, and ALJ Exhibit ("ALJX") 1. Post-hearing

briefs were received from both Complainant and

Respondent on October 20, 2003.

I. ISSUES

1. Whether Complainant engaged in activities which

are protected by the Sarbanes-Oxley Act?

2. Whether Respondent, actually or constructively,

knew of, or suspected, such activity?

3. Whether Complainant suffered an unfavorable

personnel action?

4. Whether Complainant's activity was a contributing

factor in the unfavorable personnel action taken against

him?

5. Whether Respondent has demonstrated by clear

and convincing evidence that it would have taken the

same unfavorable personnel action irrespective of

Complainant's having engaged in protected activity?

50a

Il. SUMMARY OF THE EVIDENCE

David Welch

During his direct examination, David Welch testified

that he holds both a Bachelor's degree and a Master's

degree (since 1986) in Business Administration from

East Tennessee State University (Tr. 24). He passed a

Certified Public Accountant exam in 1993 and is

currently licensed as a CPA in Virginia. /bid. He began

his career in 1991 at Quebecor Printing in Kingsport,

Tennessee as a Cost Accountant, was subsequently

promoted to a Financial Analyst and, in 1996, became a

Senior Cost Estimator (Tr. 25). He left Quebecor during

a downsizing in January 1997. bid. From June, 1997

until August, 1998, he worked as a Controller for a

physicians' group at Wellmont Health Systems. /bid.

From September, 1998 until February, 1999, Welch

worked as a Staff Accountant for Larrowe and

Company ("Larrowe & Co."), a CPA firm in Galax,

Virginia where he was responsible for bank audits and

other accounting matters, and preparing tax returns for

corporations and individuals. /bid. Welch also served as

an Adjunct Professor at Tusculum College, where he

taught finance and strategic planning classes, and at

Northeast State Community College, where he taught

payroll accounting classes (Tr. 25-26). In February,

1999, he was offered a position as Chief Financial

Officer ("CFO") at Cardinal Bankshares, a bank holding

company, and its subsidiary Bank of Floyd (hereinafter

collectively referred to as "Cardinal" or "Respondent").!

He continued to work in this position until October 1,

2002 when his employment by Respondent was

terminated. /bid. Welch testified that at the time of this

hearing, he was employed as a business manager of a

5la

physicians' group in Grundy, Virginia and was also

designing courses for an on-line accounting program at

Liberty University in Lynchburg, Virginia (Tr. 26).

With respect to how Welch obtained employment

with Respondent, he testified that while he was

working at Larrowe & Co., Mike Larrowe, a principal of

the firm, informed him that one of Larrowe & Co.'s

clients was interested in discussing a_ possible

employment opportunity with Welch (Tr. 26). Welch

expressed interest in this opportunity, and was

subsequently interviewed by R. Leon Moore, the

President/CEO and Chairman of the Board of Directors

of Cardinal Bankshares (Tr. 27). A few days later Welch

accepted an offer to be the CFO of Cardinal. Jbid.

Welch testified that during his employment Cardinal

was, and presently remains, a _ publicly traded

corporation listed on the National Association of

Security Dealers ("NASDAQ") bulletin board. /bid. He

explained that Cardinal Bankshares became a "bank

holding company" when it bought all the stock of the

Bank of Floyd and its subsidiary FBC Incorporated

(Tr. 28-29). Welch stated that a holding company was

created to allow the Bank of Floyd to take advantage of

Cardinal's widely recognized name, with an eye to

possible expansion in the future and to enable the bank

to transfer part of its capital to the holding company so

it could avoid some of Virginia's bank franchise taxes

(Tr. 29).During the relevant time period, Cardinal had

approximately 600 shareholders and Bank of Floyd was

its only subsidiary. /bid.

In his role as the CFO, Welch was responsible for

monitoring and reviewing the journal entries that were

52a

posted to the general ledger accounts of the bank and of

the holding company. /bid. In addition, he maintained

all the general ledger accounts for FBC Incorporated, a

subsidiary of the Bank of Floyd. /bid. He was also

responsible for the journal entries and all the financial

statements for the holding company. /bid. He explained

that he was initially apprised of his functions as part of

his “on the job training," and, about one year later, a job

description was developed for the CFO position which

described his duties in more detail (Tr. 28). While he

participated in the creation of this job description, he

did not draft it, but rather obtained it from Marie

Thomas and Shelby Rutherford in the Human

Resources office (Tr. 28, 357; CX 35).Welch described

his initial experience as CFO as "more or less a swim or

drown kind of thing, because I really didn't have any

formal training other than the two or three week period

that I worked with the previous CFO before he left."

Thid.

Welch testified that he became a shareholder of

Cardinal when he received three shares of its stock as a

bonus in 1999, 2000, and possibly 2001 (Tr. 30).

However, he sold all of his shares (12 shares at the

time) to another employee in late 2001 or early 2002

because his spouse was a national bank examiner and

he was not allowed to hold stock in any bank without

obtaining a waiver which required the filing of

extensive annual paperwork. /bid.

Welch testified that after he became the CFO of

Cardinal, he gained access to its financial information.

lbid. He further testified that on January 30, 2002, he

wrote a memorandum to Leon Moore stating that

Moore was improperly overriding Cardinal's internal

53a

controls (Tr. 119; CX 1). Welch explained that he wrote

this memorandum to protest the fact that certain

charge-offs were applied to a branch account instead of

the Bank of Floyd's account. /bid. According to Welch,

this was a violation of the regulatory rules, "because the

Federal Reserve says that there should never be a

debit balance in the evaluation reserve accounts" (Tr.

121). He testified that he had previously corrected

these problems with Moore's approval, however, Moore

later spoke with Gardner and Gail Phillips in the Loan

Operations Department and told them to reverse the

corrective journal entries made by Welch (Tr. at 120).*

In October 2001, Welch had some discussions with

Leon Moore with respect to the issue of insider trading

in Cardinal's publicly traded stock (Tr. 30-31). Welch

testified that shortly before the end of October, a

woman came into the bank and expressed interest in

selling all of her stock in order to pay her electric bill

(Tr. 31). Welch stated that she did not know how many

shares of stock she owned or what price she wanted,

and testified that he "wasn't confident of her mental

capabilities to make the decision she was making." /bid.

Despite his misgivings, however, Welch looked up the

current market price for the stock on the Internet, told

the woman what that price was, and she ultimately

decided to sell 26 shares at that price. Jbid. Welch

testified that he then discussed this situation with

Moore, who advised Welch that the bank could not buy

the stock "because it was too close to the end of a

quarter, and what not" (Tr. 32). However, Moore agreed

that it would be appropriate for Welch to send an email

to all employees advising them of the number of shares

available and the price (Tr. 32). Fred Newhouse, Jr.,

the Executive Vice President of the Bank of Floyd, was

54a

the first to respond andagreed to buy the stock at the

price specified by the seller. /bid.

Welch testified that although Moore had signed the

certificates sold by the woman and never objected to

this sale, he later verbally reprimanded Welch for

allowing an officer of the bank to engage in insider

trading. Jbid. Welch testified that "[wJhen I thought

about his reaction to 26 shares, for which there was no

price negotiated, it disturbed me that he could overlook

his own trades in a similar time window, but accuse

someone else of insider trading." /bid. Therefore, on

October 30, 2001, Welch wrote a memorandum to Moore

confirming the aforementioned conversation (Tr. 33; CX

6). In this memorandum, Welch described the

Securities and Exchange Commission's ("SEC")

definition of insider trading, and stated that the trades

made by Moore and "some of [Moore's] friends" had

"fallen very near the shareholders' meeting and

quarters-ended in March and September [and] more

closely fit [the definition of] insider trading" (CX 6).!

The memorandum went on to list these transactions,

including names, dates, and the number of shares

traded. /bid. Welch testified that one such transaction

involved a purchase by Moore of 420 shares on October

1, the day after the quarter ended, which, according to

Welch, was more problematic than Newhouse's

purchase of only 26 shares in advance of the quarter

end (Tr. 33). Welch added that he was also concerned

with this transaction because it took place during the

same quarter in which the earnings were overstated by

nearly 14 percent due to two entries (discussed below)

totaling $195,000 which he believed to be improper (Tr.

136).

55a

In this memorandum, Welch also listed Moore's

purchase of 243 shares, which Welch believed at the

time had taken place on April 19, 2001, only six days

prior to the announcement by Cardinal of a three for

one stock split scheduled for April 25 (Tr. 33; CX 6).

Welch acknowledged that during discovery in this case

he learned Moore had in fact issued a check to purchase

these shares around March 9, 2001 (Tr. 34; RX 2). He

testified, however, that the information he had in April

"gave the appearance of inappropriate activity" (Tr. 35).

He further explained that, as Cardinal's transfer agent

in charge of reviewing the paperwork for all stock

trades, he knew only that an order to issue stock in

Moore's name was dated April 19, 2001, and this timing

justified his concern over the transaction § as

Respondent's CFO (Tr. 38; RX 2). He added that Moore

did not tell him when he had issued a check, and instead

stated simply that he cleared this trade with an

attorney and accountant(Tr. 39, 136). To this Welch

replied that "if that was the quality of advice... he was

receiving he might consider a second source of opinion."

Ibid.

Welch further testified that the fact Moore issued a

check in March for the stock purchase made no

difference because, according to V alch, on March 9th

Moore was already aware "that a stock split was

pending" (Tr. 35). He explained that as President, CEO,

and a Board member, Moore knew about the stock split

long before Apri! 19th, and traded in stock before this

information was made public (Tr. 33-34). He added that

the stock split had been discussed for several months,

but could not specify when the final decision was made.

Ibid. He explained that "[slince a stock split doesn't

occur that frequently most times it's a discussion that

56a

takes place over an extended period of time. It's

normally not... [a] spur of the moment decision, such

as the Board meeting . .. the week before the

shareholders meeting where the split [is to be]

announced ....[The Roard members] would have had

to [seek] advice from external auditors or from other

sources of what impact a stock split would have on the

price of the stock[,] . . . on the sales or the ability to

raise additional capital. So, it would have taken a fairly

significant amount of time to gather all that information

to come to the final decision... ." (Tr. 36-37). Welch °

testified that Moore never again raised the issue of

insider trading with him (Tr. 40).*

Welch also testified regarding his efforts to report

the alleged insider trading incidents.’ He testified that

in addition to discussing his concerns with Moore, he

also reported them to the SEC by email around March

29, 2002 (CX 12, 13).7 In the document offered by Welch

into evidence as his email to the SEC, Welch stated

that as CFO and Transfer Agent for Cardinal he had

observed a number of questionable activities involving

Leon Moore, including stock purchases that Welch

classified as insider trading and improper journal

entries totaling $195,000, which inflated Cardinal's

earnings. /bid. The letter also stated that "Mr. Moore

operates under the assumption that when he yells,

everyone tucks their tails and run," and that Welch

refused to be Moore's "Yes man," even though he

realized that "this will most likely cost me my job." /bid.

Welch further testified that since Sarbanes-Oxley

was enacted on July 30, 2002, he engaged in the

following activities that he believed were protected

under the whistleblower provisions of the Act: On

57a

August 2, 2002, Welch wrote a letter to Beth Worrell of

Larrowe & Co., the auditor in charge of the Bank of

Floyd and Cardinal Bankshares audits, informing her

that he "could not sign the representation letter as they

had presented it because there were at least three

items that had problems" (Tr. 122; CX 17). In addition,

in August, 2002, he sent an email to Fred Doyle,

examiner for the State Corporation Commission's

Bureau of Financial Institutions (Tr. 123; CX 14). On

August 14th, 2002, he sent a memorandum to Moore

informing him that he could not certify the financial

statements contained in the 10-QSB for the second

quarter of 2002 and explaining the reasons for his

refusal (Tr. 121-22; CX 20). /bid. On September 13,

2002, he sent a second memorandum to Moore

describing the same problems (Tr. 122; CX 23). Finally,

on September 20, 2002, he conducted a meeting with

some of Cardinal's officers on the Sarbanes-Oxley Act

(Tr. 123; CX 25-27). Each of these activities is detailed

below.

In August 2002, Welch expressed to Beth Worrell, of

Larrowe & Co., several concerns with respect to a

"representation letter" prepared by lLarrowe &

Company for his signature. The representation letter

amounts to an acknowledgement by Welch, on behalf of

Cardinal, that Cardinal, znter alia: is responsible for the

fair presentation in the _ consolidated financial

statements of certain financial information in

conformity with generally accepted accounting

principles; has made various financial and other records

available to Larrowe & Company; and confirms there

have been no violations or potential violations of laws or

regulations, or irregularities involving management or

d8a

employees (CX 17 at 2-3). In an August 2, 2002 letter

from Welch to Worrell, Welch wrote, in part:

I received your e-mail with the representation letter

attachment and I am returning it unsigned for three

reasons.

1. All too often, journal entries (that should have prior

review) are made by persons outside the Finance

Department without the CFO's review or knowledge.

2. I cannot respond affirmatively on all items listed in

the representation letter.

3. Over the course of my tenure as Chief Financial

Officer at [Cardinal] . . . , Larrowe & Co.

hascommunicated primarily with Leon Moore "on all

issues. In fact, in the 10Qs and 10Ks you prepare, Leon

is listed as the financial officer. Over the past year to

year and a half, I have been excluded from your

communications loop almost entirely. Not having access

to all the necessary information, I cannot attest to the

validity of all entries included in our financials.

During the first half of 2002, the media has made us

acutely aware of corporate wrong doings. As a result,

this past Tuesday, President Bush signed into law a bill

that contains some pretty harsh penalties for

accounting practices that could result in financial

statements being unfairly presented. As a result, I need

a better level of comfort before signing a representation

[letter] such as yours.

(CX 17 at 1). Welch explained that the text of the

representation letter was prepared by Larrowe & Co.

59a

(Tr. 358). He also testified that he personally mailed his

August 2nd letter via the U.S. Postal Service and

enclosed in the same envelope an unsigned copy of the

representation letter, in which he _ incorporated

references to the three objections listed above (Tr. 35%;

CX 17). Specifically, he inserted a bolded, underlined,

and capitalized reference stating "see my letter dated

08/02/02 (attached) for response to this item" under the

provisions certifying: the absence of irregularities

involving management or employees who have a

significant role in internal controls; a lack of

irregularities involving other employees that could

have a material effect on the financial statements; and

the absence of violations or possible violations of laws

or regulations whose effects should be considered for

disclosure in the financial statements (CX 17 at 2).

According to Welch, he had also briefly described his

concerns over irregularities at the bank to Fred Doyle,

a bank examiner, and subsequently sent him an email

inviting Doyle to contact him after hours at home to

discuss these concerns in detail (Tr. 123, 138; CX 14).2

Welch explained that his email to Doyle did not specify

the nature of his concerns because he was worried

about Doyle showing it to Moore. Instead, Welch

wanted to meet personally with Doyle and discuss his

concerns confidentially (Tr. 188-39). Welch added that

he later had reason to believe Doyle actually talked to

Moore about Welch's concerns because "at a staff

meeting not long after the examiners left Mr. Moore

made a statement .. . that someone had gone to the

examiners, and if J remember correctly said, with a

pack of lies. And if there w[ere] any problems they

should be addressed with him and people should

remember who signs their paychecks" (Tr. 156).

60a

He testified that he wanted to report his concerns to

Moore and the bank examiner because they "had the

responsibility to report to the Board of Directors or the

Audit Committee, [and he was] hoping at least one of

them would step forward and do their jobs and make

the report" (Tr. 189). He added that it was not his

responsibility to report to the Board and Committee

because "when your boss is the President and CEO and

Chairman of the Board you can't very well go charging

into the Board Room and make accusations. Because I

feared for my job from the beginning. I wanted

someone outside who had independence, who had

authority to come in and investigate my questions" (Tr.

140). He acknowledged that he never reported his

insider trading concerns to any member of the Board of

Directors or Audit Committee, with the exception of

Moore, who was a member of both bodies. /bid. Welch

could not recall whether the insider trading issue was

ever discussed at senior managers’ or officers'

meetings, but stated that, if it was, the internal auditor

would have been present who had a duty to report it to

the Audit Committee (Tr. 140-41).

In his August 14th memorandum to Moore, Welch

cited the following reasons for refusing to certify the

Form 10-QSB for the third quarter (ending June 30,

2002) (CX 20). He first noted that "[alfter attempting to

tie Larrowe and Company's figures to our FR Y9LP,

FR Y9C and Cardinal's Consolidated financials for June

30th, I am unable to reconcile their numbers to ours."

Id. at 1. He further stated that he had told Moore

repeatedly that too many people were "making journal

entries without [his] knowledge or approval," citing as

an example the two entries totaling $195,000. Jbzd.

Welch also objected to an entry authorized by Moore at

6la

2001 year-end "charging $4,500 in expenses against

2001 income," which was later reversed (in May). Jbzd.

Welch asserted:

The result of these two sets of entries was a decrease in

taxable income in 2001, a decrease in expenses in 2002

and an increase in net income for 2002. We discussed

this practice the first year I came here. As I said then,

this type of accounting does not meet GAAP

{"Generally Accepted Accounting Principles"). It also

hints at "managing" net income which has always been

unethical and is now seriously illegal.

Ibid.

Welch's testimony then turned to a memorandum he

wrote to Moore on September 13, 2002, to which he

attached two certification forms that Sarbanes-Oxley

requires companies to file with their Forms 10-QSB

(CX 23). Welch explained that a Form 10-QSB is a

"group of financial statements that a publicly traded

company [is] required to file with the [SEC, including] .

. a statement of operations, or income statement;

balance sheet; statement of cash flows; shareholders -

change in capital based on shares bought and sold; and

other financial statements as well as commentaries of

the companies" (Tr. 42). Welch further explained that

one of these certifications (hereinafter. the “initial

certification") was required only for the first Form 10-

QSB submitted after Sarbanes-Oxley was enacted and

thus had to be filed with Cardinal's June 30, 2002 Form

10-QSB¥ (Tr. 42-48; CX 23 at 8, 9). According to Welch,

although this initial certification required the

signatures of both the CEO and CFO, Welch refused to

sign it (Tr. 43-44). Instead it was signed by Moore alone

62a

and was filed separately from the Form 10-QSB (Tr.

44). Welch testified that subsequent certifications had

to be submitted each quarter with Forms 10-QSB

starting on September 30, 2002 (hereinafter "third-

quarter certification") and required only the CFO's

signature, which Welch also refused to provide (Tr. 43;

CX 23 at 2). According to Welch, Cardinal had to file its

first quarterly certification on either November 14th or

15th of 2002 (Tr. 183).

In his September 13th memorandum to Moore, Welch

stated, in part:

Two weeks from Monday, the 3rd quarter will be

ending. Shortly thereafter, another 10-QSB will be due.

It would be my preference to avoid the friction

experienced last quarter. ... I have attached a Section

302 certification that contains the verbage (sic)

required by the Sarbanes-Oxley Act of 2002 along with

explanatory notes. The Section 302 certification is

required each quarter beginning with the September

30, 2002 10-QSB. It is also required to be part of the 10-

QSB rather than being filed as a separate document.

This is to assure its availability to anyone who wishes

to review Cardinal's financials.

The first copy of the 302 certification is as it should

be submitted except for the signature and date. The

second copy has key phrases underlined and in bold

type. Each of these phrases is connected to a comment

box which has a brief explanation as to why I will not

be able to certify the 3rd quarter's 10-QSB.

The certification submitted with your "signature" last

quarter will not suffice this quarter for two reasons.

63a

First, the Section 302 certification noted above must

now be submitted. Second, there are material items in

the 2001 3rd quarter YTD figures that should be

restated. The restatement should be done in order to

avoid the unfair presentation of financial statements

which could lead a reasonable investor to make a

decision they might otherwise not make.

I would like to address these issues with you today so

you can have something to think about over the

weekend.

(CX 23 at 1). The copies of the initial and third-quarter

certification forms attached to the September 13, 2002

memorandum contained Welch's comments explaining

his reasons for not signing these forms, with arrows

pointing to the corresponding parts of the certification

(CX 23). In addition, for each part of the third-quarter

certification that Welch felt was not satisfied, he

included in his memorandum a _ section entitled

"Comments or Recommendations" (CX 23 at 3-7).

The annotated initial certification to which Welch

referred in his memorandum stated that, for the

quarterly report for the period ending June 30, 2002, as

filed with the SEC, the undersigned CEO and CFO

were certifying, based on their knowledge and belief,

that: "(1) the Report fully complies with the

requirements of Section 13(a) or 15(d) of the Securities

Exchange Act of 1934, and (2) the information

contained in the Report fairly presents, in all material

respects, the financial condition and results of

operations of the Company as of and for the periods

covered in the Report" (CX 23 at 8).4 Welch's

annotations on the form with respect to this

64a

certification quote the Sarbanes-Oxley provision that

"whoever willfully certifies any statement as set forth

in subsections (a) and (b) of this section knowing that

the periodic report accompanying the statement does

not comport with all the requirements set forth in this

section shall be fined not more than $5,000,000, or

imprisoned not more than 2U years, or both." Jbid. His

comments on the form iso note that the initial

certification submitted by Cardinal "faill[ed] two tests:

(1) it does net contain both signatures [as the CFO's

signature was missing], and (2) it was submitted

knowing that there were issues with fair presentation

and accuracy;" that "[njo attempt was made by CEO to

bring the financial statements into compliance;" and

that "[t]he issues noted in a memo to the CEO were not

discussed with the CFO." Ibid.

A copy of the third-quarter certification attached to

Welch's September 13th memorandum is more detailed

and contains several critical comments made by Welch,

which indicate that five out of six parts of the

certification had problems that prevented him from

signing it (CX 23 at 2; Tr. 45-46). Paragraph two of the

certification contains the following language of the

Sarbanes-Oxley: "Based on my _ knowledge, this

quarterly report does not contain any untrue statement

of a material fact, or omit to state a material fact

necessary to make the statements made, in light of the

circumstances under which such statements were

made, not misleading with respect to the period

covered by this quarterly report" (Tr. 48; CX 23 at 2).

With respect to this paragraph, Welch's annotations

noted the following reason for his refusal to certify this

part: "3rd Qtr 2001 income should be restated to

properly account for the $195,000 recoveries" (CX 28 at

65a

2). In his comments attached to the annotated form,

Welch further explained this comment as follows:

In June and July of 2001, we received two recoveries [of

$45,000 and $150,000] on loans that had been written off

.... When these monies were received they should

have been given to me with an explanation as to what

they were for. Instead of booking them improperly as

income, I would have booked both . . . amounts to the

Valuation Reserve.#

As it occurred, the entries were made by someone not

having the appropriate knowledge relating to generally

accepted accounting principles, FFIEC guidelines or

IRS regulations. As a result, when I found the entries

during my monthly G/L review, I brought them to your

attention to get the entries changed.

Over the course of the last six months of 2001, I

brought this issue to your attention at each of our

Senior Officer meetings. Each time, you disagreed with

my opinion and with the regulation and refused to

change the entries. At year-end, Larrowe & Co. made

the changes as I had previously recommended.

As a result of these incorrect entries, Net Income, after

income tax effect, was overstated by 13.7% for the third

quarter of 2001 and 7.4% for the YTD September 30,

2001.

Net Loans were overstated by $195,000 (only 0.2%);

Valuation Reserves were understated by $195,000 or

14.1%; Other Liabilities were overstated by $66,300 or

17.4%, and Retained Earnings were overstated by

$128,700 or 4.5%.

66a

Therefore, the Income Statement, Balance Sheet, and

Cash _ Flov Statement for the thir ter_of

should be restated to accurately reflect the results of

operations, financial conditions, and cash flows (see

attached sample Income Statement and Balance Sheet).

(CX 23 at 3; Tr. 49).

Welch testified that, in his’ opinion, the

aforementioned effects were material and a sudden

increase in the stock price between early September

and late October, 2001 convinced him that "these

overstatements in income made Cardinal look like it

was performing really better than it was," since he

could not identify any other explanation for this

increase (Tr. at 49). In fact, a stock transfer log

prepared by Welch reflects a 21 percent increase in the

price of stock after the third quarter report for 2001

from $13.00 per share on September 6, 2001 to $15.75

per share on October 18, 2001 (Tr. 50; CX 5). Welch

testified that because he considered this increase to be

material, he concluded that these entries constituted

untrue statements that did in fact mislead investors

(Tr. 50-51). Welch further testified that he did not tell

Moore that he (Welch) could not provide a certification,

but rather his comments were intended to inform

Moore that the financial statements included with the

initial certification "needed corrections in order to meet

the requirements of Sarbanes-Oxley to avoid the

potential penalties" (Tr. 45, 48). As noted below, Welch

considered corrections eventually made by Cardinal's

management with regard to the $195,000 recoveries to

be insufficient.

67a

Welch further testified that the resulting income

increase was not offset by an expense increase:

When the checks were received and deposited there

was a debit to cash and a credit to the income accounts,

either the other income or the other real estate income.

Those were the only two entries. There were not any

offsetting expense entries. It was a debit to cash and a

credit to income.

(Tr. 359-60). Accordingly, there was no "wash" in the

third quarter of 2001 (Tr. 360).

Welch further testified he believed the fact that

Wanda Gardner, Respondent's Vice President and

Internal Auditor, made the aforementioned entries for

$45,000 and $150,000 was also problematic because "the

internal auditor should not be making journal entries to

the general ledger when she's going to be responsible

for possibly auditing those same numbers. So, there's

no independence there" (Tr. 53-54). Welch added that

he later learned that Moore was the person who had

instructed Gardner to make these entries (Tr. 54).

With reference to paragraph two of the third-quarter

certification, Welch's attached comments _ also

recommended that Respondent "[a]bide by the policies

that my job description implies are in existence" and

"allow me to follow these policies" (CX 23 at 4). Welch

ed the following examples of duties, apparently

uerived from his job description: "[clomplies and

analyzes financial information to prepare entries to

accounts, such as general ledger accounts, documenting

business transactions;" "determines proper handling of

financial transactions and approves transactions within

68a

designated limits;" and "monitors compliance with

generally accepted accounting principles and company

procedures." /bid.

Paragraph three of the third-quarter certification

states, in part: "Based on my knowledge, the financial

statements, and other financial information included in

this quarterly report, fairiy present in all material

respects the financial condition, results of operation and

cash flows of the registrant as of, and for, the periods

presented in this quarterly report" (CX 28 at 2). Welch

testified that he could not certify this part for the same

reason he refused to certify paragraph two (Tr. 51-52;

CX 23). He stated that on at least two occasions he

attempted to convince Cardinal's management to

correct this problem at the senior managers' meetings

in the presence of Moore, Gardner, Compliance Officer

Diane Hamm, and other employees (Tr. 53-54). Welch

further testified that, after performing the year-end

audit of Cardinal, Larrowe & Co. ultimately

acknowledged that Welch was right (Tr. 54-55).

Specifically, in January 2002, Beth Worrell, the auditor

for Larrowe & Co., investigated Cardinal's accounts for

inappropriate entries and reversed the two

aforementioned entries totaling $195,000 disputed by

Welch, after Welch directed her attention to “hese

entries (Tr. 55). However, according to Welch, these

reversals corrected only the misstatement of income for

the year end, but not for the third quarter of 2001 (Tr.

55-56). According to Welch, this is problematic because

under the existing requirements, "the third quarter's

income svatements and balance sheets [for 2001] would

appear in the following year in the third quarter of 2002

as comparative statements" relied upon by the

investors (Tr. 56, 71). Welch testified that prior to their

69a

meeting on September 20, 2002, he recommended to

Moore that this mistake be corrected by restating the

financials, but it was never done (Tr. 56-57).

Finally, with reference to paragraph three of the

third-quarter certification, Welch included the

following recommendation: "permit me to perform the

job functions as outlined in my job description,"

including those listed under part two above, as well as

the following: "audits contracts, orders, and vouchers,

and prepares reports to substantiate individual

transactions prior to settlement," and "reviews,

investigates, and corrects errors and inconsistencies in

financial entries, documents, and reports" (CX 28 at 4).

Paragraph four of the third-quarter certification

states in relevant part: "The registrant's other

certifying officers and I are responsible for establishing

and maintaining disclosure controls and procedures (as

defined in [the Act] for the Registrant and have; (a)

designed such disclosure controls and procedures... ;

(b) evaluated [their] effectiveness [within] 90 days prior

to the filing date of this quarterly report . . .; and (c)

presented in this quarterly report our conclusions about

[their] effectiveness... ." (Tr. 57; CX 23 at 2). Welch's

attached comments state that "[Larrowe & Co.]

communicates exclusively with CEO on all disclosure

matters" (i.e., to the exclusion of Welch), that Welch

had not "participated nor been consulted in the design

of disclosure controls and procedures, and that [he] has

not evaluated their effectiveness" (CX 23 at 2). With

respect to Welch's attached comments regarding

paragraph four, he provided’ the following

recommendation: "[plermit me to review the disclosure

70a

controls and procedures you have put into place in

order to evaluate their effectiveness" (CX 23 at 5).

Welch testified that after the Sarbanes-Oxley Act

was signed into law on July 30, 2002, he informed the

management that he would not be able to make this

certification because Cardinal had not complied with its

requirements (Tr. 57). He further testified that, to his

knowledge, no disclosure controls and procedures had

been designed (Tr. 58). Welch stated that he was aware

in August 2002 that disclosure controls had to be

designed in time for the third-quarter certification due

in mid-November, but he repeatedly testified that he

did not believe that designing these controls was his

responsibility as the CFO (Tr. 58, 131-34). He explained

that designing this system was, he believed, the

responsibility of the external auditors since: (1) it was

their job to determine whether the necessary financial

information had been fairly disclosed when they

prepared the annual audit report and reviewed Forms

10-QSB and 10-KSB; and (2) the Act itself imposed this

responsibility on the senior management and external

auditors (Tr. 133-34). He later testified that he at least

expected the external auditors to provide guidance on

this matter, because he would not be able to determine

what disclosures were required without their assistance

(Tr. 130-31, 183). Welch explained that he was not in a

position to determine specifically what had to be done

to comply with the Act's requirements despite having

attended a CFOs' conference on the Sarbanes-Oxley

Act on September 9th and 10th, 2002 because the

conference was short (approximately an hour and a half

long) and focused mainly on the highlights of the Act

and the required certifications (Tr. 74, 95-96, 130). He

added that the language of the certification did not

71a

suggest to him he was the individual responsible for

designing controls, and when he wrote the August 14th

memorandum he knew little about the requirements of

the Act which had only been in effect for two weeks

(Tr. 131) Besides, according to Welch, his

memorandum was not attempting to resolve "whose

responsibility it was, it was just these things need to

happen before certification can go forward. And at this

point some of the guidance, final guidance, had not been

issued" (Tr. 131-32). He acknowledged, however, that

he never asked Mike Larrowe for help with designing

controls (Tr. 134).

‘Paragraph five of the certification states: "The

registrant's other certifying officers and I have

disclosed, based on our most recent evaluation, to the

registrant's auditors and the audit committee or

registrant's board of directors ...: (a) all significant

deficiencies _in the design or operation of internal

controls ...; and (b) any fraud, whether material or not,

that involves management or other employees who

have a significant role in the registrant's internal

controls" (CX 23 at 2). Welch's comment for this part

states: "No evaluation. The CFO isn't permitted to

address Audit Committee or Board." /bid. His comment

referencing sub-part (a) indicates that: “[o]nly the

deficiency of too many non-accounting people making

[journal entries]w/o Finance review or approval has

been brought to the attention of CEO & External

Auditors.“ Dual control does not make an entry meet

GAAP." E Jbid. Welch clarified that the "internal

control system is the guidelines by which journal

entries ... get into the general ledger" (Tr. 61). He

explained that although Cardinal used the dual control

system for approving such entries, he was not given a

72a

chance to review such entries, as required by his job

description. /bid. According to Welch, such entries

often failed to follow the generally accepted accounting

principles, as did the $195,000 recovery and some

"sundry expenses,’ because they were made and

approved by people outside the Finance Department

who did not have the financial expertise necessary to

determine whether those entries satisfied such

accounting principles (Tr. 61, 63-64; CX 15).”

Also with reference to sub-part (a) of paragraph five,

Welch's memorandum stated, in part:

Since you [i.e., Leon Moore] are the only person who

reports to the board and I have been instructed by you

not to address the audit committee and you have been

the (practically) exclusive contact with Larrowe & Co.,

I cannot certify any portion of this statement.

This is not a situation seen in very many banks. Most

banks have at least two officers on the board for

purposes of accountability as well as for providing

diversification of opinion on... operational issues that

come before the board.

(CX 23 at 5).

With regard to the sub-part (b) requirement to

disclose all fraud, Welch's comments state "if insider

trading is fraud, it has been reported to CEO" (Tr. 66;

CX 23). Welch testified that he found it significant that

mishandling even small amounts of money would

violate Sarbanes-Oxley as long as there was "the intent

to deceive." /bid. He added that, in his opinion, the

aforementioned journal entries and insider trading

73a

constituted fraud. Jbid. The attached comments also

asserted that, as Welch had previously indicated to

Moore, "the practice of making credit entries to Sundry

Credits (liability account) and debit entries to Sundry

Expenses at year-end ... are misleading to the financial

statement reader" (CX 238 at 6). He went on to say that

even more misleading were the entries made in the

following year that reversed the sundry credits entries

(debits) and reduced the expense accounts because "[a]s

a result of this second set of entries, it appears that

expenses for the second year are !ess than they actually

were, thus, overstating income in the second year" (CX

23 at 6; Tr. 64-65). Welch asserted that this practice was

inconsistent with generally accepted accounting

principles which require "that income and expenses be

matched against the period in which they are incurred."

Ibid. During his direct examination, Welch testified

that this practice had “the appearance of manipulating

income" or "pumpl[ing] up" earnings at mid-year, "which

is a significant milestone for investors." Jbid. Welch

further testified that this practice was "something that

all the regulators strictly prohibit" (Tr. 65). In

particular, "according to FASBE 140” the only way to

reverse those entries legally was either the debts were

paid, the expenses were paid, or it's released by a Court

of law or by judicial action" (Tr. 358-59). Instead, they

were reversed when "around the middle of the

following year, there were credit entries made to

various expense accounts and debits made to the

sundry credits account" (Tr. 359). Welch testified that

such reversal was not appropriate because "it did not

constitute payment nor did it constitute judicial release

of the liability" (Tr. 359). Welch's comment under sub-

part (b) again reiterated that Respondent needed to

74a

permit him to perform the job functions outlined in his

job description (CX 23 at 6).

Even prior to the September 138th memorandum,

according to Welch, he had brought to Moore's

attention the aforementioned problems concerning

paragraphs two through five of the certification (Tr.

66). He also stated that since Moore served as the

Chairman of the Board of Directors, was President and

CEO, and a member of the Audit Committee "in all

those roles he was the conduit for information to the

Audit Committee, to the Board of Directors" (Tr. 67-

68).

On September 13th, 2002, Leon Moore wrote a

memorandum responding to Welch's September 13th

memorandum, stating, in part:

I am well aware of the certification process and I am

well aware of the needs that you have discussed. Please

review all of the notes that you have made and expound

on those in more detail. Give me any suggestions that

you have on each of those. I too want to avoid friction or

misunderstanding such as we experienced last quarter.

You must understand that these reports will be

certified. In the future, to enhance communications,

your memos will need to be presented in person for

discussion.

(CX 22).

Despite his refusal to sign the initial and third-

quarter certifications, Welch acknowledged that prior

to the enactment of the Sarbanes-Oxley Act he signed

consolidated financial statements and _ reports of

75a

condition (call reports) relating to the bank and its

holding company which were filed quarterly with the

Federal Reserve (RX 7 and 8). Welch testified that he

realized at the time that some of these reports were

inaccurate, but did not report these problems because

[A]t my age it's difficult to change careers and I

believed before Sarbanes-Oxley came along that what

has happened to me would have happened. I would

have been terminated. I would have been in a position

with the gap of my employment as a Chief Financial

Officer at a bank which would raise questions with

potential employers. Apparently that's what has

happened, because for six months after my termination.

After dozens and dozens of applications and resumes

there were no contacts from anybody, even for

interviews. Until Sarbanes-Oxley came along I didn't

-feeltike I had any legal standing to support my

positions or to protect me.

(Tr. 141-42).

Welch gave several additional reasons why he signed

these financial reports yet refused to sign the

aforementioned certifications. First, he testified that, at

the time the 2001 call reports for the second and third

quarter were prepared, he had not yet discovered the

inappropriate entries for the $195,000 recovery. He

further stated that, even after he found these entries,

he signed a call report because he was still convinced

that he could persuade Moore to make the necessary

changes (Tr. 70-71; CX 8). Second, Welch testified that,

unlike Forms 10-QSB, the call reports are not public

documents relied upon by investors and do not contain

comparative statements (Tr. 71). Third, Welch pointed

76a

out that different reports require different levels of

review (Tr. 69-70). In particular, the call reports, unlike

Forms 10-QSB, required him merely to review the

financials for any "significant" problems, and the other

reports he signed contained no certification or review

requirements (see e.g., RX 8 at 5) (Tr. 69-70, 71-72). By

contrast, the Sarbanes-Oxley Act, which pertains to the

quarterly report (Form 10-QSB) and the annual report

(Form 10-KSB), required a certification that all

statements are accurate anc not misleading, and

provided for significant fines and prison terms for

violations (Tr. 72). Welch stated that the Act not only

exposed him to this risk, but also promised to protect

his employment, and provided him with the legal

authority to back his position. /bid.

On September 17, 2002, Cardinal's board of directors

held a meeting to address the allegations raised by

Welch in his September 13, 2002 memorandum. The

minutes of the meeting reflect that it was attended by

Moore, Larrowe, Gardner, K. Venson Bolt, who was

Vice Chairman of Cardinal and Chairman of the Audit

Committee, and Cardinal's attorney Douglas W.

Densmore (CX 33# at 1). Moore opened the meeting by

reading Welch's September 138th memorandum and a

response prepared by Moore to Welch bearing the same

date. Moore stated that the allegations Welch made in

his memorandum were unfounded and, in part,

reflected Welch's own failure to do his job and his

deteriorating relationship with the company. J[bid.

Moore reported that difficulties with Welch began

approximately two years ago when Welch instructed

Larrowe & Co. to review a Form 10-QSB and other

financial reports prior to their filing. /b¢d. Since that

time, Welch became increasingly "disaffected and

77a

apparently unwilling or unable to do what needs to be

done to comply with the law." /bid.

Moore cited several areas of concern to the board

regarding Welch's performance. First, he stated that in

August 2002, state bank examiners had cited fifteen

errors in the second quarter call report, which Welch

blamed on Larrowe & Co. and on the fact that he was

out on sick leave when the report was filed. bid.

According to Moore, the examiners were concerned

that no one in the Financial Department was trained to

act as a backup to Welch. /bid. Moore further stated

that he had repeatedly instructed Welch prior to the

state examination regarding the need for backup

training, but no training took place even though there

were individuals who were willing and able to be

trained. Moore further reported that the Bank had

purchased software at the cost of $4,000 that would

enable the ITI system to interface with and load

information into the call report. /bid. Although Welch

was instructed to work with the Data Processing

Manager on implementing this new software, he

refused to use it and continued to manually enter data

into the call report using Excel spreadsheets. Jbid. The

examiners had, according to Moore, also noted that

many of the charts, graphs, and spreadsheets prepared

by Welch were unnecessary and time-consuming. [bid.

Moore's second concern related to Welch's allegation

that figures had to be corrected for the purposes of

filing the 2001 third quarter Form 10-QSB, including

the aforementioned

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