U.S. Supreme Court Hears PCAOB Case: Is All of Sarbox in Jeopardy?

Lora Bentley

Roughly 2 1/2 years ago when I still wrote more about Sarbanes-Oxley than any other piece of legislation or regulation or industry standard, the Free Enterprise Fund and a small accounting firm in New Jersey, among others, filed a lawsuit against the Public Company Accounting Oversight Board. The suit alleged that the PCAOB, and by extension, the Sarbanes-Oxley Act of 2002, were unconstitutional because its members were not appointed by the president subject to the advice and consent of the Senate, as required by the Appointments Clause in Article II, Section 2 of the U.S. Constitution.


The media and every company subject to the act's requirements were in a frenzy when the news first broke, in large part because the Sarbanes-Oxley Act does not have a severability clause. That, of course, meant that if the court were to decide the portion creating the PCAOB is unconstitutional, the entire act would be struck down.


According to Jones Day partner Michael Carvin, who spoke with me shortly after the U.S. District Court for the District of Columbia dismissed the Free Enterprise Fund's case, the court agreed with the FEF on the merits of the case, but had disagreed on the issue of standing. In other words, the court found that the Free Enterprise Fund and the other plaintiffs had not been harmed by the violation, and thus, they were not the proper parties to bring the action.


On appeal, the U.S. Court of Appeals for the District of Columbia Circuit agreed with the lower court that the issues raised in the case did not merit a trial. According to The Washington Post's report on the decision, the plaintiffs lost much of their case decades ago "when the Supreme Court upheld the constitutionality of independent agencies."


Not to be dissuaded, the FEF took the case all the way to the U.S. Supreme Court, and Monday, the justices heard oral argument in the case. According to an opinion piece by The Wall Street Journal's James Freeman:

The most powerful czar in Washington will receive some long-overdue scrutiny today when the Supreme Court hears a challenge to the constitutionality of the Public Company Accounting Oversight Board (PCAOB)...Yet Sarbanes-Oxley, or Sarbox, itself should be subject to scrutiny. New research suggests that the costs of this legislation far outweigh its benefits to the investing public.


Freeman goes on to point out specific costs of the much-maligned piece of legislation, including at least $2.3 million in direct compliance costs per year per company, and "an historic drought in intial public offerings" in the United States. In fact, he says the legislation's saving grace is its lack of a severability clause, which I mentioned earlier. It goes without saying, I guess, which way Freeman hopes the Supreme Court comes down in this case.

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Dec 9, 2009 8:37 PM John C. Blackshire, Jr. John C. Blackshire, Jr.  says:

Yes, we all know that SOX was a very poorly consturctured Act.

Yes, we all know the CPA firms needed to be better regulated.

Yes, we all know the public companies are spending too much money on compliance because they are still stuck on compliance with AS 2 rather than AS 5

Yes, we need to be prepared for Congress will replace SOX with something else that may not be to our liking. The devil we have may be better than the devil that could be recreated.

Dec 14, 2009 3:32 PM James J. Finn James J. Finn  says: in response to John C. Blackshire, Jr.

Your points are excellent, but here is a different perspective on each point.

1. Yes, Sarbbox was poorly crafted because section 404 was based on the assumption that public companies were already compliant with the FCPA internal control requirements. This was not always true and distracted attention away from the focus on regulating CPA firms which was a primary intent.

2. Yes, CPA Audit firms needed real regulation, or, alternatively maybe "Deregulation" since they were put in business by the Securities Act of 1934 which required a public audit of financial reporting. Just eleminate this legal audit requirement since it didn't seem to accomplish its intended purpose.

3. Yes, using AS-2 probably cost billions because it only applies to (and is only appropriate for) "Auditors" not companies. Unfortunatly, AS-5 is the same. The most appropriate guideline appears to be the SEC's interpretative guidance which was finalized for companies in 2007.


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