Lawsuits may expand Sarbanes-Oxley

Protections sought for mutual fund workers

Two lawsuits filed by former employees against Fidelity Investments may resolve a simmering dispute in the securities industry: Whether mutual fund employees are protected by a whistle-blower law adopted in the wake of corporate accounting scandals.

Congress gave whistle-blowers at public companies strong protections against retaliations when it passed the Sarbanes-Oxley Act in 2002 after the collapse of Enron Corp. and WorldCom. But the law does not specifically extend to privately held firms such as Fidelity that invest in public companies.

Now, groups such as the Consumer Federation of America argue that to protect millions of retail investors, the whistle-blower rules should also apply to companies that run mutual funds sold to the public. The rules require companies to set up ways for employees to report claims anonymously and set penalties including fines and prison terms for retaliation.

The most recent lawsuit against Fidelity involves a former portfolio manager, Jonathan M. Zang, who claims he was fired for loudly complaining about company business practices, such as how Fidelity discloses the way it pays fund managers. Filed Tuesday in US District Court in Boston, Zang's suit contended his termination was a violation of Sarbanes-Oxley.

However, Zang had previously made the same argument about Fidelity in a complaint he filed with the Occupational Safety & Health Administration, which oversees claims brought by would-be whistle-blowers. An adminis trative law judge for OSHA sided with Fidelity in determining that Sarbanes-Oxley doesn't apply to the company because of its corporate structure.

Technically, the funds are separate entities that hire Fidelity investment unit FMR Co. as the funds' manager, and in her March 27 decision the judge wrote that Zang had failed to show a tight enough connection between the company and the funds.

For instance, she wrote that just because Fidelity chairman Edward C. Johnson III also owns shares in Fidelity funds "does not establish common ownership" that would give Zang the protections of Sarbanes-Oxley.

Noting the company prevailed before OSHA, Fidelity spokeswoman Anne Crowley, said Zang's claims "are without merit and we will vigorously defend against this suit" in federal court. Also, she said, the company has processes in place for employees to anonymously report ethical concerns without fear of retribution. "We don't retaliate against employees who bring us information," she said.

The second lawsuit was filed in March by former Fidelity senior director Jackie Hosang Lawson, who says she was forced out after questioning the way Fidelity set fund fees.

In a motion filed yesterday Fidelity called her claims "meritless" and wrote that, "Unfortunately, there are employees who attempt to use Sarbanes-Oxley's protections as leverage against their employers and in an effort to shield themselves from legitimate employment actions. That is what happened here." Moreover, Fidelity isn't a public company and so isn't covered by Sarbanes-Oxley, the filing states.

The lawsuits have prompted consumer activists to petition the Securities and Exchange Commission to determine that Sarbanes-Oxley's whistle-blower protection requirements extend to fund firms such as Fidelity. The activists wrote to the SEC in late March that the industry's biggest scandals were brought to light by whistle-blowers such as Peter Scannell, who first exposed improper trading activities at his employer, Putnam Investments in Boston.

"It is inconceivable that Congress did not intend that mutual fund shareholders enjoy the benefits afforded to shareholders of other publicly traded companies with respect to whistle-blowers," they wrote.

The groups include the Consumer Federation of America and Mercer Bullard, a University of Mississippi law professor who runs a fund shareholders advocacy organization. Bullard said SEC officials have arranged to discuss the matter with him soon. Bullard served as a paid witness for Zang in his OSHA case, but has not represented Lawson.

Bullard noted however, that even if Sarbanes-Oxley were extended to fund companies, the protections may not be worth much. He cited studies such as a 2007 University of Nebraska paper that found OSHA reviewers sided with would-be whistle-blowers just 3.6 percent of the time.

Zang's case stems from complaints he made in 2005 over how Fidelity planned to disclose portfolio manager compensation in a securities statement the company was going to file with the SEC. He said he told his Fidelity superiors the statement had inaccuracies, and then repeated his accusations in a March 13 e-mail he sent to dozens of Fidelity colleagues. He also sent notes to top executives including Abigail Johnson, a member of the company's controlling Johnson family who at the time ran FMR Co.

He also claimed Fidelity was operating "veiled index funds," which charge fees as if they were actively managed but in reality mimic various securities indexes.

Zang claimed in his lawsuit that Fidelity eventually changed some disclosures about compensation. But, he said company officials began to criticize his job performance, called his March 13 e-mail "unacceptable and unprofessional," and said it violated Fidelity rules on electronic communications.

The company terminated him in July 2005, which Fidelity later explained was part of a management reorganization of its investment company, according to the complaint. The suit claims the real motive was retaliation for his activities that should have been protected under Sarbanes-Oxley.

Ross Kerber can be reached at kerber@globe.com.