Supreme Court Audit Board Case Could Reopen Sarbanes-Oxley Debate

By | December 7, 2009

The Supreme Court hears a case on Monday that could alter how corporate America is audited and overhaul the Sarbanes-Oxley corporate reform act.

The outcome of the case will determine whether a central component of the Sarbanes-Oxley law — an independent board to police auditors of public companies — continues to exist in its current form.

Created in response to accounting scandals at Enron and WorldCom, the Public Company Accounting Oversight Board (PCAOB) was created to help restore investor confidence in capital markets by holding auditors accountable.

But a conservative activist group called the Free Enterprise Fund and a small Nevada accounting firm contend the PCAOB violates the U.S. Constitution’s “separation of powers” and “appointments clause” because it is not accountable to the U.S. president.

PCAOB members are appointed by the Securities and Exchange Commission, in consultation with the Federal Reserve Board and the U.S. Treasury Department.

Oral arguments before the Supreme Court are scheduled to begin at 10 a.m. (1500 GMT) on Monday. A ruling is not expected for several months.

Free Enterprise Fund sued in 2006, contending that the Sarbanes-Oxley law unconstitutionally stripped the president of power to appoint or remove board members, or to supervise or control their activities. While the PCAOB is set up as a quasi-private agency, it acts as a powerful government agency with authority to impose rules, investigate and punish accounting firms for rule violations, according to Free Enterprise Fund.

The case made its way to the Supreme Court after a federal judge and then an appeals court rejected the challenge.


If the high court rules against the PCAOB, Congress would be forced to revisit the Sarbanes-Oxley Act, thus opening it up for reform and potentially changing companies’ reporting duties.

The reform law forced companies to disclose more information, required managers to sign off on financial statements, and imposed audit requirements on firms. But it has also been criticized for driving up business costs and making the United States a less-attractive location than some other global markets.

Scott Garrett, the top Republican on the U.S. House Financial Services subcommittee on capital markets, wants small companies to be exempt from Sarbanes-Oxley’s reporting requirement on the effectiveness of their internal controls.

But with policymakers under pressure to reform how the U.S. financial services system is supervised, the Sarbanes-Oxley law could become even stronger and the PCAOB given more authority. The board could soon start inspecting auditors of brokerages in the wake of the Bernard Madoff investment scandal. Madoff used a small unknown auditor that was not registered with the Board.

Before Sarbanes-Oxley became law, the accounting industry regulated itself and was criticized for weak standards and enforcement as well as potential conflicts of interests because private regulators had to depend on contributions from the accounting industry for funding.

The PCAOB is funded through fees it collects from public companies. It inspects thousands of auditors, including the Big Four accounting firms: Ernst & Young LLP, KPMG , PricewaterhouseCoopersand Deloitte & Touche LLP.

Seven former SEC chairmen have voiced support for the PCAOB, saying it helped restore investor confidence in the stock market and improved the quality of corporate audits.

(Reporting by Rachelle Younglai; editing by John Wallace)

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