Appeals Court Upholds Sarbanes-Oxley Act

By David S. Hilzenrath
Washington Post Staff Writer
Friday, August 22, 2008; 12:39 PM

A federal appeals court today upheld the Sarbanes-Oxley Act of 2002, the government's most sweeping attempt to protect investors since Franklin D. Roosevelt's New Deal.

The U.S. Court of Appeals for the District of Columbia Circuit rejected a challenge to the heart of the act, the creation of a nonprofit board to set auditing requirements and police the accounting firms that audit public companies.

The legislation, adopted in response to devastating accounting abuses at companies such as Enron and WorldCom, was meant to restore public confidence in the stock market, make executives more accountable and improve the audits, on which shareholders depend, to keep companies honest. Among other things, it required top executives to certify corporate financial statements and subjected audit firms to periodic inspections by the new board.

Businesses have protested that the act imposed costly burdens and provided too little benefit. The legal challenge was brought by Beckstead and Watts, a Nevada accounting firm that the oversight board accused of performing flawed audits, and the Free Enterprise Fund, which advocates reduced taxes and limited government, according to court papers.

Today's 2 to 1 decision by a three-judge panel can be appealed to the full court of appeals or directly to the Supreme Court, neither of which is obligated to consider the case. Lawyers for the losing side did not respond to a request for comment, including whether they will appeal.

The plaintiffs in the lawsuit argued that the Sarbanes-Oxley Act violated the Constitution's separation of powers by investing the Public Company Accounting Oversight Board (PCAOB) with governmental authority while insulating it from presidential supervision and control. They also argued that the act subverted the president's power over appointments by having board members appointed by majority vote of the Securities and Exchange Commission. Defenders of the Sarbanes-Oxley Act said in a court filing that the case against the law was tantamount to an assault on independent agencies -- a reference to such long-established regulators as the SEC, the Federal Trade Commission and the Federal Communications Commission, which are not directly controlled by the president.

Writing for the appeals court panel's majority, Judge Judith W. Rogers said the plaintiffs lost the bulk of their case more than 70 years ago when the Supreme Court upheld the constitutionality of independent agencies. In addition, the SEC, whose members are nominated by the president and confirmed by the Senate, has broad authority over the board, including the power to change its rules, limit its operations and block any sanctions it proposes against auditors, she said.

The Sarbanes-Oxley Act "vests a broad range of duties" in the accounting oversight board, but the board's "exercise of those duties is subject to check" by the SEC "at every significant step," Rogers wrote. She was joined in the majority by Judge Janice Rogers Brown.

In dissent, Judge Brett M. Kavanaugh wrote that Sarbanes-Oxley renders the accounting oversight board "unaccountable and divorced from Presidential control to a degree not previously countenanced in our constitutional structure." He said "such unaccountable power is inconsistent with individual liberty."

The challenge to the accounting oversight board also called into question other private sector regulatory bodies that operate under SEC supervision such as the Financial Industry Regulatory Authority, which disciplines brokers, and the New York Stock Exchange, which regulates listed companies, defenders of the act contended.

U.S. District Court Judge James Robertson threw out the suit last year, asserting that its legal theories did not merit a trial. The plaintiffs had appealed.

The fact that President Bush's Justice Department joined in the defense of the Sarbanes-Oxley Act was noteworthy in part because the lawsuit framed the act as an encroachment on presidential power. The Bush administration has generally fought to expand presidential power.

SEC Chairman Christopher Cox said the appeals court decision "is welcome news for the commission, investors and U.S. capital markets."

"The commission believes that the PCAOB is a highly effective organization whose continued existence is vital to protecting investors and furthering the public interest in the preparation of accurate and informative audit reports," Cox said in a written statement.

Seven former SEC chairmen filed a brief in support of Sarbanes-Oxley, as did the Council of Institutional Investors and several pension funds for public employees.

The lawyers waging the case against the act included Michael A. Carvin, a former Justice Department official who represented then-candidate George W. Bush in litigation over the 2000 election recount in Florida, and Kenneth W. Starr, the former judge and solicitor general who investigated President Bill Clinton's relationship with Monica Lewinsky.

Though the lawsuit focused on constitutional issues, the parties behind it had other grievances. A leader of the Free Enterprise Fund, Republican fundraiser Mallory Factor, has argued in print that the act damaged the economy and made it possible for chief executives to be sent to jail for honest mistakes.

Meanwhile, the Nevada accounting firm Beckstead and Watts suffered damage to its reputation as a result of PCAOB action, according to a legal brief. Beckstead and Watts said the board was demanding too much from audits of small companies.

The Sarbanes-Oxley Act took aim at a system in which auditors, who are supposed to serve as watchdogs, were widely accused of serving as lap dogs for the companies they audited. Corporate profit statements that were later found to be deeply flawed or fraudulent passed muster at big audit firms, such as the now-defunct Arthur Andersen.

Under the old system, big audit firms inspected each other and found little to criticize. They pursued lucrative consulting contracts from the companies they audited, giving auditors another reason to curry favor with their clients. Their main lobbying organization wrote auditing rules that made it hard to hold auditors accountable for fraud or negligence, and they faced little discipline.

Under Sarbanes-Oxley, consulting was restricted, and the new board replaced the lobbying group as the auditors' overseer. In the years since President Bush signed the law, corrections to corporate financial statements became more commonplace, as have disclosures that companies had serious weaknesses in their internal controls. Accounting firms received consolation in the form of expanded audit work--and bigger audit fees.

But the oversight board faced a backlash. Under pressure from business and the SEC, it last year eased requirements that it had put in place three years earlier for audits of companies' internal controls,

The act is named after Maryland Democrat Paul S. Sarbanes, former chairman of the Senate Banking Committee, and Ohio Republican Michael G. Oxley, former chairman of the House Financial Services Committee.

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