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The U.S. Supreme Court hears a case today that grew out of a financial scandal - not a recent one, but one that dates to the beginning of this decade, the Enron Scandal. The legal issue is whether an oversight board created by Congress is constitutional. And more than that could be at stake, as NPR legal affairs correspondent Nina Totenberg reports.
NINA TOTENBERG: Sitting here today as Congress debates what measures are needed to avoid a repeat of the financial institution failures of the last year, it's hard to remember that eight years ago, there was a different kind of scandal that shook the foundations of the business world. It involved the collapse of some of the nation's largest corporations - Enron, WorldCom, Tyco - and how those companies had deceived their investors through sham outside audits. Enron's bankruptcy in 2001 was, at the time, the largest in U.S. history.
Mr. PAUL SARBANES (Former Democratic Senator, Maryland; Former Chairman, Senate Banking Committee): It turned out that Enron was the canary in the mine shaft.
TOTENBERG: Paul Sarbanes was then chairman of the Senate Banking Committee.
Mr. SARBANES: You had major companies engaged in convoluted, often fraudulent, accounting schemes to inflate their earnings, to hide losses, and to drive up their stock prices.
TOTENBERG: And the outside audits of these companies, even though conducted by industry standards, were worthless.
The debacles provoked a crisis in confidence in capital markets. After extensive hearings, Democrat Sarbanes, and his Republican counterpart in the house, Michael Oxley, coauthored a bill to ensure that investors would get accurate financial information about publicly traded companies. President Bush signed the bill into law in 2002.
Instead of allowing the accounting industry to regulate itself, as it had in the past, the law created the Public Company Accounting Oversight Board, the PCAOB - or as it's uncharitably known, peekaboo. The board is technically private, funded by a fee charged to public accounting firms. Its five board members are top accounting specialists appointed by the Securities and Exchange Commission.
But pro-business conservatives have attacked the board as unconstitutional, contending it's a hybrid institution accountable to no one that both makes rules to govern public accounting and enforces them. Lawyer Michael Carvin.
Mr. MICHAEL CARVIN (Lawyer): If you combine the ability to make laws and enforce the law, that's what King George did. And that is the ultimate definition of tyranny.
TOTENBERG: The challenge to the law was brought by a conservative anti-regulation, anti-tax group called the Free Enterprise Fund, and one of its members, Brad Beckstead, who runs a small public company auditing firm.
Mr. BRAD BECKSTEAD (Owner, Auditing Firm; Member, Free Enterprise Fund): I became the poster boy for what they labeled as rogue audit firms.
TOTENBERG: As Beckstead tells it, seven board inspectors spent 14 days in his office and found his audits deficient. He says his clients, though publically traded, were tiny startups with limited resources and that using industry standards, he scaled the audits to the size of each firm.
Mr. BECKSTEAD: The PCOB(ph), for two years, were making my life miserable. It became so burdensome to comply with their constant requests that I was no longer profitable.
TOTENBERG: Representing Beckstead and the Free Enterprise Fund, Michael Carvin challenged the Sarbanes-Oxley law in court and lost, appealing ultimately to the U.S. Supreme Court, where the case is to be argued today.
Carvin contends that the law violates the Constitution's requirement that the powers of the three branches of government be separate, and that the president be able to enforce the laws with officers he appoints and can fire. He argues that the PCAOB is unconstitutional because the SEC, not the president, appoints the board.
Mr. CARVIN: It's exercising extraordinarily powerful government, potentially tyrannical power. And what kind of control does the president have over it? None. Zero.
TOTENBERG: That's nonsense, says former Senator Sarbanes.
Mr. SARBANES: Any actions they take have to have the okay from the SEC.
TOTENBERG: And this isn't token supervision, say seven former chairmen of the SEC, both Democrat and Republican. Rod Hills, one of the Republican former chairmen, has served for five years on the PCAOB advisory board.
Mr. ROD HILLS (PCAOB Advisory Board): For those years, I have seen no rule adopted by the PCAOB that wasn't pre-cleared with the SEC.
TOTENBERG: He says the board meets laboriously with the SEC over its budget, its rules and any disciplinary actions. Nothing, not even a subpoena, can be issued without the permission of the SEC. Indeed, Hill says the control is so great that it is of considerable frustration to PCAOB board members.
The government defends the constitutionality of the board, noting that the president must appoint and the Senate must confirm the board's boss, the SEC commissioners. The commissioners, so the argument goes, are principal officers, like Cabinet secretaries. And the people they supervise - in this case, the PCAOB - are inferior officers not directly controlled by the president under the Constitution. In other words, the board is no different than the general counsel of the SEC or the agency's chief enforcement officer.
Those challenging the PCAOB note that the board members can only be fired for cause, meaning some egregious conduct. But the government contends that's a red herring, since the SEC can eliminate the salaries of the PCAOB, its budget, and can even take functions away from the board. There are big stakes in this case, more than meet the casual eye.
Professor RICHARD PILDES (Law, University of New York): That is basically an attack on the constitutionality independent agencies.
TOTENBERG: NYU law Professor Richard Pildes wrote the Supreme Court brief for the former SEC chairman.
Prof. PILDES: At the end of the day, I think what's fascinating about this case in a way is that it's almost the last gasp of the sort of unitary executive branch theory which we hear a lot about over the last generation.
TOTENBERG: The unitary executive theory was espoused by conservatives - among them now-Chief Justice John Roberts and now-Justice Samuel Alito - when they served in the Reagan and Bush administrations in the 1980s.
The theory, which had a kind of conservative rebirth then, contends that independent agencies like the SEC, the Federal Trade Commission, the Federal Communications Commission, that these independent agencies of the modern administrative state are unconstitutional because while the agency commissioners are appointed by the president, they can only be fired for cause, so the president doesn't have complete control over them.
The problem, says professor Pildes, is that conservatives have consistently lost that legal battle, beginning 75 years ago, and again in the 1980s.
Prof. PILDES: I think fundamentally what's going on here is an effort to sort of re-litigate that big battle in the context of the SEC and this new board.
TOTENBERG: Mr. Carvin, the lawyer challenging Sarbanes-Oxley, almost admits as much. The constitution, he observes, doesn't mention the SEC.
Mr. CARVIN: So if the president can't tell the SEC what to do because they're independent, then the fact that the SEC nominally controls the PCAOB is completely irrelevant.
TOTENBERG: If the independent agencies created in the new deal are a fourth branch of government, he contends�
Mr. CARVIN: But the PCAOB is a fifth branch.
Mr. HILLS: This is a philosophical argument that's kind of fun, but it's too serious.
TOTENBERG: Too serious, says former SEC Chairman Rod Hills, in terms of repercussions for the regulation of our capital markets.
Mr. HILLS: What they're really trying to do after all these years, we do far too much damage to our system.
TOTENBERG: Now the Supreme Court will decide.
Nina Totenberg, NPR News, Washington.
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