Supreme Court Justices Question Audit Board Under Sarbanes-Oxley

By | December 8, 2009

Several U.S. Supreme Court justices seemed to question Monday whether the president had enough authority over an agency that polices auditors of public companies.

During arguments to consider if the Public Company Accounting Oversight Board violates the U.S. Constitution, the justices scrutinized the president’s control over the semi- private regulator.

The outcome of the case could alter how corporate America is audited and strike at the heart of the Sarbanes-Oxley corporate reform law, enacted in response to accounting scandals at Enron and WorldCom.

“Suppose the president objects to the very large salaries that the members of the board receive. Suppose … he says this is outrageous, I want to change it. How can he do that?” Justice Samuel Alito asked the government’s top courtroom lawyer, Solicitor General Elena Kagan.

The chairman of the PCAOB typically earns well over $500,000 — more than president of the United States and the chairman of the Securities and Exchange Commission (SEC).

Kagan argued the president had adequate control over the board through the SEC, which is its supervisor.

At issue is the Constitution’s separation of powers principle and appointments clause, which requires the White House to appoint principal officers.

The Free Enterprise Fund and a small Nevada accounting firm appealed to the Supreme Court, saying the Sarbanes-Oxley law unconstitutionally stripped the president of power to appoint or remove board members or to supervise their activities.

PCAOB members are appointed by the SEC and can only be removed by the SEC for cause — a relationship Chief Justice John Roberts questioned.

“The board can act and the SEC can, I suppose, retroactively veto their actions,” Roberts said. “But the SEC doesn’t propose what actions the board takes, actions that can have significant, devastating consequences for the regulated bodies.”

While the PCAOB is set up as a quasi-private agency, it has authority to impose rules, inspect and fine accounting firms.

The Free Enterprise Fund argues PCAOB members should be deemed principal officers, not so-called inferior officers who do not need presidential appointments.

“Do you know any other agency composed of inferior officers that has the power to acquire its own budget, as this board does, by simply assessing a tax upon the people that it regulates?” Justice Antonin Scalia asked the lawyer for the PCAOB, Jeffrey Lamken.

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 , PricewaterhouseCoopers and Deloitte & Touche LLP.

The Free Enterprise Fund sued in 2006. The case made its way to the Supreme Court after a federal judge and then an appeals court rejected the challenge.

CONGRESSIONAL ACTION?

If the high court rules against the PCAOB, Congress would be forced to revisit the Sarbanes-Oxley law, thus opening it up for reform and potentially changing the reporting duties of companies. It is not known when the court will rule, but a decision is expected before the end of June.

“There was no doubt in my mind that the case troubled some of the justices,” said former SEC Chairman Harvey Pitt.

He refused to forecast which way the court would rule.

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

A number of U.S. lawmakers want small companies to be exempt from Sarbanes-Oxley’s reporting requirement on the effectiveness of their internal controls.

But with Congress under pressure to reform financial regulation, the PCAOB could become even more powerful.

The accounting industry used to regulate itself and was criticized for weak standards and enforcement, as well as potential conflicts of interests because private regulators were dependent on industry for funding.

(Reporting by Rachelle Younglai; editing by Steve Orlofsky,John Wallace and Andre Grenon)

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