Supreme Court Leaves Sarbanes-Oxley Intact

The U.S. Supreme Court left intact the centerpiece of the Sarbanes-Oxley Act while ruling that the executive branch should have more authority over members of the Public Company Accounting Oversight Board.

The 5-4 decision released today said the 2002 law passed in response to accounting frauds at Enron Corp. and WorldCom Inc. didn’t give the president enough say over the board created by the act. The Securities and Exchange Commission must have unfettered power to fire the board’s chairman and members in order for it to adhere to separation of powers provisions in the Constitution, the high court ruled.

“No one doubts Congress’s power to create a vast and varied federal bureaucracy,” Chief Justice John Roberts wrote in the majority decision. “But where, in all this, is the role for oversight by an elected president?”

Concern that the Supreme Court would issue a more sweeping ruling had prompted the SEC to put together contingency plans to take over some of the accounting board’s duties if it was dissolved. The decision gives the SEC broader authority to remove members without requiring any further action by regulators or lawmakers, said Christopher Bartolomucci, a partner at Hogan Lovells in Washington.

“The effect of the court’s decision is quite limited,” he said. “The board will continue to exist and its regulatory powers will be the same.”

SEC Chairman Mary Schapiro, in a statement, said she’s “pleased that the court has determined that the board’s operations may continue.” The accounting board, in a statement, said no legislation is needed to make the board’s structure constitutional.

Enforcement Actions

Congress created the five-member board to replace a system in which the accounting industry policed itself. The Washington- based board writes rules for audits of public companies, inspects firms and has authority to bring enforcement actions.

The SEC oversees the board by appointing its chairman and members, approving its budget and signing off on its rules. The SEC can only terminate a board member for cause.

Beckstead and Watts LLP, a Henderson, Nevada-based accounting firm, and a group advocating for limited government challenged the board’s constitutionality in a lawsuit. Lawyers for the plaintiffs argued that because the president lacked control, the board “and all power and authority exercised by it” violated the constitution.

“We reject such a broad holding,” Roberts wrote. “Instead, we agree with the government that the unconstitutional tenure provisions” don’t undermine the entire Sarbanes-Oxley law.

The decision divided the court along ideological lines. Justices Antonin Scalia, Clarence Thomas, Samuel Alito and Anthony Kennedy joined Roberts’s majority opinion.

Kagan Case

The Obama administration defended the accounting board, saying the SEC exercised comprehensive control over the board’s activities, including the auditing standards it issues and the enforcement actions it takes. U.S. Solicitor General Elena Kagan, now a Supreme Court nominee, argued the case for the government.

In dissent, Justice Stephen Breyer said the majority’s reasoning raised constitutional questions about a myriad of other government entities.

The decision “will create an obstacle, indeed pose a serious threat, to the proper functioning of that workable government that the Constitution seeks to create,” Breyer wrote.

Justices John Paul Stevens, Ruth Bader Ginsburg and Sonia Sotomayor also dissented.

Fees

The accounting board has issued a series of auditing standards and taken 25 enforcement actions since opening its doors in 2003. The board funds its work by imposing fees on public companies.

Congress set salaries for board members that exceed the pay of most public officials to make the jobs competitive with accountants working in the private sector. The chairman receives $672,676 a year and board members get $546,891.

President Barack Obama makes $400,000 and Schapiro receives $165,300. SEC commissioners are paid $155,500 annually.

Among rules drafted by the accounting board is a standard stemming from Sarbanes-Oxley that outlines what auditors must do to ensure companies have adequate safeguards to prevent financial misstatements and fraud. The board revised the rule in 2007 after companies complained that audits were saddling them with unnecessary compliance costs.

Congress went a step further last week in negotiating financial regulation legislation to respond to the 2008 crisis. Lawmakers exempted all companies with market values below $75 million from having to comply with Sarbanes-Oxley audit rules.

The case is Free Enterprise Fund v. Public Company Accounting Oversight Board, 08-861.

To contact the reporters on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net; Greg Stohr in Washington at gstohr@bloomberg.net.

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