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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 2009

## Text

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WW \ 98-836 JAN2- 2009

No.
CLERK

IN THE

Supreme Court of the United States

DAVID E. WELCH, CPA, PETITIONER
v.

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

i
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?

uw
TABLE OF CONTENTS

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TABLE OF AUTHORITIES

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CASES
Affiliated Ute Citizens v. United States, 406 U.S. 128

CN ics ii eis lain etnias Saisicta peal eed atria ait al aces cident 21
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

SS, BE svpenteehcccmicipalinnuie ea aaieannaisin 21
Ernst & Ernst v. Hochfelder, 425 U.S. 425 U.S. 185

CP IN Rass Arcecoia. vias leticeaasan abled adasieilon alate dite dae tall a ae 20
Lewis v. United States, 445 U.S. 55 (1976) uu... eee 20
Livingston v. Wyeth, Inc., 5380 F .8rd 344 (4"" Cir. 2008) ...... 6, 7
National Assn. of Home Builders v. Defenders of

pg ek A =,» RORIMRLIINRDR Saigon teen ANN ER 21
SEC v. Capital Gains Research Bureau, Inc., 375

sah EG SN sicpaicsakioniccendy crcsibaaloseelesis ude aetbieldasaeainibtaienaie 21
Smith v. Corning, 496 F. Supp. 2d 244 (W. D.N.Y

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STATUTES
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FR ae icine cancaenmenolenab em 19
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Oe a es Feta ccexten tina ect een cea 20
Ba ec cs eeceninnien dtsehaeatesescaupeenasietae tiamnranoiean a yas buenas 5
eit I sicikiccrncchsvenncatiesstinedeebiasauchen aici deel leameamenal 5
i oe ii sasinintnttem hatin teclictadntecosyioinbiaiiadadanan 10, 20
Ee EE ie er Pir siin sents deosvcanrsisioeenreeseininceee’ 2, 11,12
28 U.S.C. § 1254(1)........ stielinaahinbiaasntataldlusen ca ialidiabiaaialitnia 2
Be ai cehstits isis sceci sities cnsshikdigs lots aaa ioaniaildnadcaca tates 2
REGULATIONS

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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

2

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

3
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

(C) a person with supervisory authority
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.

a

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

6
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

7

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

8
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
<=.

—_—

——~

)
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 ).

10

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

11

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

12
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

13
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).

14
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

15

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

16

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.

17

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

18
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

19

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

20

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

21

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).

22

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

23

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.

24
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

la

(any footnotes trail end of each document)
No. 07-1684
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

DAVID E. WELCH, CPA,
Petitioner,
v.

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,

2a

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

3a

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.

I.

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,

4a

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

5a

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

6a

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

7a

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

8a
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

9a

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.

A.

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.

B.

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.

V.

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

(C) a person with supervisory authority 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 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
atto

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386020_0959%3A1. Public record. Not legal advice.