Preclusive Effect of an Arbitration Award: A Ruling that Will (Literally) Knock Your “Sox” Off

by Lionel M. Schooler, FCIArb
Jackson Walker LLP¹

Introduction. In Hansen v. Musk (yes, that Musk), 122 F.4th 1162 (9th Cir. 2024), the United States Court of Appeals for the Ninth Circuit addressed a question of first impression about the impact of an arbitration award on an ongoing dispute where the arbitration of certain other claims was statutorily precluded. The controversy arose within the context of claims arising under or related to the Sarbanes-Oxley Act of 2002 (“SOX”), which prevents SOX claims from being subject to mandatory arbitration. The Court concluded that when an arbitrable matter was sent to arbitration, and where the arbitrator’s ruling in that dispute was confirmed in federal court, to the extent that the losing party attempted to relitigate issues that had already been presented to the arbitrator, relitigation was precluded by the terms of the award.

Background: Underlying Facts of Claims. Mr. Hansen was initially employed by Tesla in an investigative role. When he reported concerns about internal theft and misconduct, including potential surreptitious monitoring of employee communications, his employment was terminated. He then went to work for a Tesla contractor that provided security services at the same facility, the Tesla “Gigafactory.” In that role, he continued his investigations into alleged criminal activity at the Gigafactory, eventually submitting a report to the SEC (among others) about alleged misconduct by Tesla. When Mr. Musk learned that Mr. Hansen was working at the Gigafactory, he insisted that the subcontractor terminate Mr. Hansen’s employment, which it did.

Background: Claims Filed by Plaintiff. Mr. Hansen then sued Tesla and Mr. Musk for violations of state and federal law, including a violation of the Sarbanes-Oxley Act of 2002 (“SOX”), having to do with investor protection from fraudulent financial reporting.

Background: Motion to Compel Arbitration. In response, the Defendants moved to compel arbitration of most of the claims. This motion was triggered by the wording in the employment agreement Mr. Hansen had signed with the subcontractor, which mandated arbitration of disputes arising out of his assignment to the Tesla facility. Even so, Defendants recognized that Mr. Hansen’s SOX claim could not be arbitrated, given the SOX prohibition of enforcement of any pre-dispute arbitration agreement, as specified in 18 U.S.C. §1514A(e)(2).

The District Court granted the motion to compel arbitration. As for the claims that arose under SOX, the Court stayed those claims pending the outcome of the arbitration, but noted that such claims arose from the same conduct that had prompted Mr. Hansen’s lawsuit.

Background: Results of the Arbitration. In the arbitration, Mr. Hansen asserted multiple new claims, including claims for violations of the federal RICO statute, and violation of the Dodd-Frank Wall Street Reform and Consumer Protection Act’s protections for whistleblowers. The Arbitrator disposed of Mr. Hansen’s RICO claims in two interim awards, holding that Mr. Hansen had failed to adequately allege either a pattern of racketeering activity or a cognizable injury. The Arbitrator granted summary judgment to Defendants on Mr. Hansen’s claim for breach of contract and one of his claims for tortious interference with his contractual relationship with the subcontractor, finding that Mr. Hansen had no contractual right to continue working at the Gigafactory.

Thereafter, the Arbitrator issued a final award on June 8, 2022, rejecting Mr. Hansen’s remaining claim of tortious interference with contract and his claim of retaliation under Dodd- Frank. The Arbitrator found the tortious interference claim failed because Mr. Hansen had no contractual right to be assigned to work at the Gigafactory.

As to the Dodd-Frank claim, the Arbitrator determined that Mr. Hansen had been transferred from Tesla to the subcontractor because Tesla outsourced the work of all such employees to the subcontractor. Further, the Arbitrator found that Mr. Hansen’s position at the Gigafactory had not been terminated because of his complaint to the SEC, but rather because Mr. Hansen had emailed significant amounts of confidential information to third parties and had then attempted to cover his tracks by deleting such emails. The Arbitrator also found that the subcontractor could not have retaliated against Mr. Hansen for any protected activity because it had never been made aware of the activity that Mr. Hansen claimed was protected.

Regarding Mr. Hansen’s claim alleging a violation of Dodd-Frank whistleblower protections, the Arbitrator determined that because that claim required proof that a reasonable person would have believed that the activities he reported violated securities laws, the claim failed because Mr. Hansen could not have reasonably held such a belief. Rather, to the Arbitrator, such complaints referred only to “[g]arden variety theft and drug violations,” generally governed by state and local law, not Dodd-Frank. The Arbitrator indicated in his Award that, regarding this claim, Mr. Hansen had testified that he was not even aware of what was reported to Tesla’s shareholders or included in its financial statements.

Background: District Court Rulings on the Award and its Aftermath. The case then returned to the District Court, where the Defendants moved to lift the stay as to all claims, including the SOX claim, and to confirm the arbitration award. Mr. Hansen did not oppose this motion, and the District Court accordingly granted it.

Defendants then moved to dismiss the entire lawsuit, contending that the findings by the Arbitrator precluded Mr. Hansen from relitigating whether he had engaged in protected activity under SOX, whether his subsequent employer (the subcontractor) had known about such activity, and whether the subcontractor had taken any adverse action against Mr. Hansen on the basis of such protected activity (the centerpiece of his SOX claim). The District Court granted the motion and dismissed the entire lawsuit with prejudice, focusing upon the decision by the Arbitrator that Mr. Hansen could not have reasonably believed that his complaints implicated any securities law violations, nor any claim to “blow the whistle” as to any other fraudulent conduct covered by SOX. Mr. Hansen then lodged an appeal to the Ninth Circuit, contending that he had been wrongly deprived of the opportunity to litigate his SOX claims.

Issue Presented. Whether a federal court can confirm an arbitration award in such a way as to preclude SOX claims that are otherwise prohibited from being compelled to arbitration.

Appellate Review. The Court of Appeals commenced its review of the lower court’s decision by noting that it had the authority to affirm the decision on any ground supported by the record. It further noted that it had the authority to review, de novo, whether issue preclusion was available as to pending claims, reviewed for abuse of discretion.

Turning first to the arbitration award itself, the Hansen Court noted that confirmation of an arbitration award has the same force and effect as a final judgment on the merits, including the same preclusive effect on subsequent litigation raising related claims. Even so, it acknowledged that it had never before evaluated the extent to which, if at all, an arbitration award could have the preclusive effect advocated by the Appellees in this case.

The Hansen Court then considered Mr. Hansen’s argument that applying the arbitration award as having preclusive effect violated the “separability” commanded by SOX in connection with arbitration awards. The Hansen Court concluded that while an arbitrator’s decision can never preclude a SOX claim, a confirmed arbitral award can sometimes preclude relitigation of the issues underlying such a claim because arbitral factual resolutions may bear upon the status of a non-arbitrable statutory claim.

The Hansen Court therefore determined that such impermissible relitigation would occur in this case, given that the confirmed award conclusively resolved all facts underlying Mr. Hansen’s statutory claims. As a result, the Hansen Court affirmed the District Court’s judgment upholding the arbitration award and its preclusive effect on Mr. Hansen’s statutory SOX claims.

Conclusion. The Hansen decision illustrates the extent to which a statutory bar to compulsory arbitration can, under certain circumstances, be precluded by the evidence and the decision evolving from an arbitration award.

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¹ Mr. Schooler is a former Member of the Board of the CIArb North America Branch, and the immediate PastChair of the Texas Chapter.