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Supreme Court takes narrow approach on anti-fraud law

By David S. Hilzenrath
Washington Post Staff Writer
Monday, June 28, 2010; 1:39 PM

The Supreme Court on Monday left almost completely untouched an oversight board for corporate auditors that was the centerpiece of the government's response to the accounting scandals at Enron and WorldCom.

In a case that could have invalidated the board and the broader Sarbanes-Oxley Act, signed by President George W. Bush in 2002, the court took a much narrower approach.

The court declared that the five members of the oversight board can be removed by the Securities and Exchange Commission for any reason, striking the part of the Sarbanes-Oxley Act that said the SEC could remove board members only for good cause.

"The consequence is that the Board may continue to function as before, but its members may be removed at will by the Commission," Chief Justice John G. Roberts Jr. wrote for the majority.

"With the tenure restrictions excised, the Act remains 'fully operative as a law,' " the court said.

A lawsuit brought by a small auditing firm and an advocacy group called the Free Enterprise Fund challenged the constitutionality of the Public Company Accounting Oversight Board, saying it violated the separation of powers by assigning an executive role to officials beyond presidential control. The suit focused on the fact that board members are appointed by the SEC, not the president, and were insulated from removal by the president.

"It is a tremendous victory for the Public Company Accounting Oversight Board," Joel Seligman, president of the University of Rochester and co-author of a treatise on securities regulation, said by voice mail.

Lynn Turner, a former chief accountant at the SEC, said the opinion leaves the oversight board "subject to the political whims of the SEC chairman and SEC commissioners." But, based on the board's past relationship with the SEC, he said, that might not be a change.

In a dissent to the 5-4 decision, Justice Stephen G. Breyer said the reasoning of the majority would leave in question the status of many government officials, including leaders of independent agencies, members of the senior executive service and military officers.

"Reading the criteria above as stringently as possible, I still see no way to avoid sweeping hundreds, perhaps thousands of high level government officials within the scope of the Court's holding, putting their job security and their administrative actions and decisions constitutionally at risk," Breyer wrote.

But Roberts said "nothing" in the opinion "should be read to cast doubt on . . . what is colloquially known as the civil service system within independent agencies," and he said the dissent "wanders far afield" in raising questions about military officers. Roberts did not address those issues in depth.

"There is no reason for us to address whether these positions identified by the dissent, or any others not at issue in this case, are so structured as to infringe on the President's constitutional authority," he wrote.

The case was Free Enterprise Fund v. Public Company Accounting Oversight Board.

The Sarbanes-Oxley Act created the nonprofit oversight board to set audit standards, inspect auditing firms and share enforcement duties with the SEC. In so doing, the law entrusted sensitive regulatory responsibilities to a nongovernmental organization, though it gave the SEC broad powers over the oversight board.

Instead of drawing its funds from the federal Treasury, the oversight board collects a fee from publicly traded companies. Its pay scale also diverges from the government's: Members of the five-person board receive salaries of $546,891.

Previously, the auditing industry wrote the rules governing corporate audits, and the rules insulated auditors from accountability. To uphold standards, accounting firms periodically evaluated one another in a system of peer reviews that critics derided as mutual back-scratching. The accounting profession and the SEC shared responsibility for disciplining auditors, but their track record was weak.

The impact of the oversight board is difficult to gauge because its work is largely secret. The Sarbanes-Oxley Act handed the accounting industry a victory by tightly restricting what the board is permitted to disclose about investigations, enforcement actions and the results of routine inspections of accounting firms.

Auditing firms have long faced pressure to take a less-than-confrontational approach to the companies they audit because they are hired and paid by those companies. In the pre-Enron era, they routinely marketed consulting services to their audit clients, too; Sarbanes-Oxley reined in that practice.

Businesses have been trying to roll back aspects of the law almost since Bush signed it, and they won a major battle days ago when House and Senate conferees finished a bill to overhaul financial regulation in response to the recent economic crisis. The bill would scale back by about half the number of companies required to have their internal controls audited, exempting those with a stock market value of $75 million or less.

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