Court Weighs Sarbanes-Oxley In the wake of the financial scandal that destroyed Enron, Congress created an independent board to watch over the accounting of all publicly traded firms. In order that the Public Company Accounting Oversight Board have total independence from political influence, Congress deemed that its members be appointed by the Securities and Exchange Commission. The court heard arguments Monday that challenge whether Congress went too far and overstepped the Separation of Powers clause of the Constitution.


Court Weighs Sarbanes-Oxley

Court Weighs Sarbanes-Oxley

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In the wake of the financial scandal that destroyed Enron, Congress created an independent board to watch over the accounting of all publicly traded firms. In order that the Public Company Accounting Oversight Board have total independence from political influence, Congress deemed that its members be appointed by the Securities and Exchange Commission. The court heard arguments Monday that challenge whether Congress went too far and overstepped the Separation of Powers clause of the Constitution.


Here in Washington today, the Supreme Court seemed on the edge of invalidating the anti-fraud law passed in the wake of the Enron scandal. The law overhauled the way publicly traded companies are audited. The goal was to ensure that investors get an accurate picture of a company's finances.

NPR legal affairs correspondent Nina Totenberg reports.

NINA TOTENBERG: Enron's collapse in 2001 was, at the time, the largest bankruptcy in U.S. history. Soon, other huge American corporations went belly-up, leaving investors who'd been deceived by sham outside audits holding the bag.

In response, Congress passed the so-called Sarbanes-Oxley Law, named for its principal authors. Whereas auditors had been self-regulated in the past, the law set up an independent board of top accounting specialists charged with monitoring outside audit firms.

The board is funded by a fee charged to the audited firms. It's appointed by the Securities and Exchange Commission and is supervised by the commission. But pro-business conservatives unhappy with the law are attacking it as unconstitutional.

On the steps of the Supreme Court today, lawyer Michael Carvin, representing the Free Enterprise Fund, acknowledged that if he's successful, business interests that have chafed at new regulations will have a chance to rewrite the law.

Mr. MICHAEL CARVIN (Lawyer, Free Enterprise Fund): If in the process of fixing the unconstitutional board, Congress makes some commonsense adjustments to the substance of Sarbanes-Oxley, I think the Free Enterprise Fund would be very happy.

TOTENBERG: Inside the courtroom, Carvin had a generally receptive audience. The Court's two most recent Bush appointees, Chief Justice John Roberts and Justice Samuel Alito, both railed against the independence of agency action when they served in the executive branch. They saw these agencies as rogue entities, unaccountable to the president. And Justice Antonin Scalia has long been an outspoken critic of any regulatory system that doesn't give the president the direct power to hire and fire.

That left the Court's more liberal justices, particularly Ginsburg and Breyer, asking the skeptical questions. Ginsburg objected to Carvin's characterization of the auditing oversight board as an unaccountable, independent agency. It's not independent of the SEC, she said. It can't do anything without the approval of the SEC. It can't even issue a subpoena.

Carvin contended, though, that the SEC itself is at the outermost limits of constitutional acceptability and that the oversight board imposes a burden on citizens outside the SEC's control. Justice Kennedy: What's the burden? Answer: The time and cost of compliance with the auditing rules.

Carvin had a pretty easy time of it compared to Solicitor General Elena Kagan, defending the statute. Kagan: The board is in no different position than the staff of the SEC. It must get its budget, its salaries, its investigative rules and its sanctions approved by the SEC.

Scalia, Roberts and Alito pounced. Roberts questioned the need for an independent board. Kagan replied, Congress wanted the board to be independent of the accounting industry, not the SEC.

Roberts: Then why did Congress set up a separate board? Answer: For two reasons. With the SEC strapped for resources, Congress wanted to set up a system of auditing oversight that has its own separate funding stream, namely fees paid by the audited companies. And second, Congress wanted to get the board outside of the normal civil service laws so that it could attract specialists who are normally paid much more. Kagan said this is the same system used by other quasi-public regulators that overseas stockbrokers and the stock exchanges.

Justice Alito: What are the salaries of the board members? Answer: They're over $500,000 and the SEC has been very active in reviewing them.

Justice Alito: Supposing the president reads about this and says, this is outrageous. I want to change it. How can he do that? Answer: Just as he would with any other SEC function, he or his staff would call the SEC commissioners and say, I have a problem with this.

Justice Scalia, sarcastically: I could do that. Kagan pushed back: Justice Scalia, that's what the Supreme Court held in 1935, that the president cannot order independent agencies to take specific actions in the same manner that he can order cabinet departments to act.

Chief Justice Roberts focused on the question of firing. The president can only remove the SEC commissioners for cause, meaning misconduct. And the SEC, in turn, can only remove board members for cause. Said Roberts: That's for cause squared and that's a significant limitation on the president's power that this court has not recognized before.

Representing the oversight board, lawyer Jeffrey Lamken contended that there's no real difference in the powers of the board and the powers of the SEC staff. In fact, right now, the SEC staff can issue subpoenas without asking the commission for consent. That's more than the accounting board can do.

As for the removal provisions for board members, he said, they are no different than those governing other boards under SEC control that exists throughout the financial regulatory system. If you start pulling at those regulatory threads, he seemed to say, you could be unraveling the fabric of the country's regulatory system and leaving investors with no meaningful protection.

Nina Totenberg, NPR News, Washington.

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Supreme Court Considers Sarbanes-Oxley Board

Supreme Court Considers Sarbanes-Oxley Board

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The U.S. Supreme Court hears arguments on Monday testing the constitutionality of the federal anti-fraud law that grew out of the Enron scandal. At issue is the constitutionality of the board Congress created to oversee independent audits of publicly traded companies.

But even more could be at stake.

As Congress debates what measures are needed to avoid a repeat of the financial institution failures of the last year, it is hard to remember that eight years ago, a different kind of scandal shook the foundations of the business world. It involved the collapse of some of the nation's largest corporations — Enron, WorldCom and Tyco — and how those companies deceived their investors through sham outside audits. Enron's bankruptcy in 2001 was, at the time, the largest in U.S. history.

"It was the canary in the mine shaft," says Paul Sarbanes, who in 2001 was chairman of the Senate Banking Committee.

"You had a number of major companies engaged in convoluted, often fraudulent, accounting schemes to inflate their earnings, to hide their losses and to drive up their stock prices," he observes.

And the outside audits of these companies, even though conducted by industry standards, were worthless.

The debacles provoked a crisis of confidence in capital markets. After extensive hearings, Democrat Sarbanes and his Republican counterpart in the House, Michael Oxley, co-authored a bill to ensure that investors would get accurate financial information about publicly traded companies. President George W. Bush signed it into law in 2002.

Instead of allowing the accounting industry to regulate itself, as it had before, the law created the Public Company Accounting Oversight Board, the PCAOB, or, as it is uncharitably known, "peekaboo." The board is technically private and is funded by a fee charged to the firms being audited. 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. They contend it is a hybrid institution accountable to no one, that both makes rules to govern public accounting and enforces them.

Lawyer Michael Carvin, arguing Monday in the Supreme Court, says that the law is unconstitutional. He says that "combining the the ability to make laws and enforce them [is] what King George did." That, he says, is "the ultimate definition of tyranny."

Carvin represents the Free Enterprise Fund, the conservative, anti-regulation, anti-tax group that is bringing the challenge. One of the group's members, Brad Beckstead, runs a small public company auditing firm and became the focus of PCAOB inspectors in 2004. He says the board made him "the poster boy for what they labeled as rogue audit firms."

As Beckstead tells it, seven board inspectors spent 14 days in his office and found his audits deficient. Although his clients were publicly traded, he says that they were tiny start-ups with limited resources, and that using industry standards, he scaled the audits to the size of each firm.

"The PCAOB for two years was making my life miserable," Beckstead says. "It became so burdensome to comply with their constant requests that it was consuming my time and my staff's time, and I was no longer profitable as a business."

Beckstead and the Free Enterprise Fund challenged the Sarbanes-Oxley law in court, and lost, appealing ultimately to the U.S. Supreme Court.

Arguing on their behalf, 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.

The PCAOB "is exercising extraordinarily powerful government, potentially tyrannical power," he contends. "And what kind of control does the president have over it? None. Zero." If President Obama wanted to "fire these morons," Carvin says, he couldn't.

That's nonsense, says former Sen. Sarbanes. Any actions the board takes "have to have the OK of the SEC."

And this isn't token supervision, according to seven former chairmen of the SEC, both Democrat and Republican. Roderick Hills, one of the Republican former chairmen, has served for five years on the PCAOB's advisory board and says that in that time he hasn't seen any PCAOB rule adopted without "pre-clearance from the SEC."

He says the board meets "laboriously" with the SEC over the PCAOB budget, rules and disciplinary actions. Nothing, not even a subpoena, can be issued without the permission of the SEC. Indeed, Hills says the control is so great that it is of considerable frustration to the board's 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 members, are inferior officers not directly controlled by the president under the Constitution. In other words, the board is no different from the general counsel of the SEC or the agency's chief enforcement officer.

Those challenging the PCAOB note that the board's members can only be fired for cause — meaning for some egregious action. But the government contends that it is 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.

On both the left and the right, the case is seen as a legal attack on the legitimacy of all independent agencies. "It's almost the last gasp of the unitary executive branch theory which we heard a lot about over the last generation," says NYU law professor Richard Pildes, who wrote the brief on behalf of the former SEC chairmen.

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 of the modern administrative state — the SEC, the Federal Trade Commission, the Federal Communications Commission, for instance — are unconstitutional because, while 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 Pildes, is that conservatives have consistently lost that legal battle, beginning 75 years ago, during the New Deal, and again in the 1980s. He sees this case as an effort to relitigate that big battle in the context of the SEC and this new board.

Carvin, the lawyer challenging Sarbanes-Oxley, almost admits as much. The Constitution, he observes, doesn't mention the SEC. "If the president can't tell the SEC what to do because they are independent," he argues, "then the fact that the SEC nominally controls the PCAOB is completely irrelevant.

And if the independent agencies created in the New Deal are a so-called fourth branch of government, he contends the PCAOB is the "fifth branch."

That would be "a fun philosophical argument," says former SEC Chairman Hills, but it is "too dangerous," in terms of the repercussions for capital markets. "What they are trying to do would do far too much damage to our system."

Now the Supreme Court will decide.