Supreme Court to Hear Challenge to Constitutionality of Sarbanes-Oxley Provision
Tuesday, May 19, 2009
The Supreme Court yesterday agreed to consider a challenge to the Sarbanes-Oxley Act of 2002, the centerpiece of the government's response to the watershed accounting scandals at Enron and Worldcom.
The case tests the constitutionality of a nonprofit oversight board created to regulate auditors of public companies. Plaintiffs in the case, including a Nevada accounting firm, allege that the oversight board was endowed with unchecked government powers.
If the court agrees, it could force Congress to reopen the debate over one of the most sweeping pieces of business legislation since the 1930s. Supporters say the Sarbanes-Oxley Act has helped protect investors; critics say it has imposed costly burdens on corporations.
The court accepted the case for consideration in the term that begins in October.
Congress enacted Sarbanes-Oxley after big accounting firms such as the now-defunct Arthur Andersen failed to protect shareholders from a wave of accounting manipulations that made corporations look healthier and more profitable than they really were. Until 2002, the accounting profession was largely responsible for making its own rules and overseeing itself.
Under Sarbanes-Oxley, a new Public Company Accounting Oversight Board was given the power to set auditing standards, inspect audit firms and investigate suspected wrongdoing by firms that certify the reliability of corporate financial statements.
Plaintiffs in the Supreme Court case allege that the authors of the act set out to insulate the board from political pressure and went too far. They contend that the act leaves the president with insufficient control over what are essentially executive functions, thereby violating the constitutional separation of powers.
Among other things, plaintiffs object to the fact that members of the oversight board are appointed by the Securities and Exchange Commission, which they say impinges on the president's authority to make appointments.
The lawsuit challenging the act was filed by Beckstead and Watts, an accounting firm that the board accused of performing flawed audits, and the Free Enterprise Fund, which calls for limited government.
The U.S. Circuit Court of Appeals for the District of Columbia rejected the suit last year, when a three-judge panel of split 2 to 1. Before that, a trial judge had thrown out the case.
In the earlier appeal, parties filing briefs in defense of Sarbanes-Oxley included the Council of Institutional Investors, which represents big pension funds, and seven former chairmen of the SEC.
The board "plays a critical role ensuring that audited financial statements meet investor needs," Jeff Mahoney, general counsel of the Council of Institutional Investors, said yesterday.
Urging the Supreme Court not to take the appeal, the Justice Department argued that Congress modeled the oversight board on so-called self-regulatory organizations that oversee stock exchanges and stockbrokers. The SEC has the ultimate authority over every aspect of the oversight board's work, the Justice Department wrote.
The lawsuit is widely seen as part of an assault on other aspects of the Sarbanes-Oxley Act, including the requirement that corporations obtain audits not only of their financial statements but also of their internal controls.
If the oversight board were declared unconstitutional, it would not be difficult for Congress and the SEC to correct the defects, said Georgetown law professor Donald C. Langevoort. But if Congress were forced to revisit the legislation, the result could be a legislative free-for-all for interest groups, including those seeking to change other aspects of Sarbanes-Oxley, said Columbia law professor John C. Coffee.
"As a practical matter, once this goes back to Congress" -- if it does -- "it may be irresistible for the Congress to re-examine the whole thing," said Christian G. Vergonis of Jones Day, who represents plaintiffs in the case.
Staff researcher Robert Thomason contributed to this report.