Sarbanes-Oxley Upheld By Court as Constitutional

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By David S. Hilzenrath
Washington Post Staff Writer
Saturday, August 23, 2008

An appeals court yesterday upheld the Sarbanes-Oxley Act of 2002, dismissing arguments that the government's attempt to protect investors from repeats of the scandals at Enron and WorldCom gave federal overseers unchecked power.

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 a wave of corporate accounting abuses, 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.

Lawyers for the losing side said they plan to appeal yesterday's 2-to-1 decision by a three-judge panel.

The decision is "one more reason for Congress to step up to the plate on comprehensive modernization of our regulatory structure," said David Hirschmann, senior vice president of the U.S. Chamber of Commerce. The Chamber of Commerce was not a party to the case, but it views the accounting oversight board as part of a larger regulatory drag on the economy.

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 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 PCAOB 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 an impassioned dissent, Judge Brett M. Kavanaugh wrote that the Sarbanes-Oxley Act renders the PCAOB "unaccountable and divorced from Presidential control to a degree not previously countenanced in our constitutional structure."

The majority sided with U.S. District Judge James Robertson, who threw out the suit last year, asserting that its legal theories did not merit a trial.

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.

Seven former SEC chairmen filed a brief in support of the Sarbanes-Oxley Act, 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, 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, Beckstead and Watts suffered damage to its reputation as a result of PCAOB action, according to a legal brief. Beckstead and Watts asserted that 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 the interests of 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 PCAOB 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 Paul S. Sarbanes (D-Md.), former chairman of the Senate Committee on Banking, Housing and Urban Affairs, and Michael G. Oxley (R-Ohio), former chairman of the House Financial Services Committee.

Sarbanes wasn't blind to the constitutional issues involved in the lawsuit. When the law was being drafted, he sought legal advice on some of the same questions.


© 2008 The Washington Post Company

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