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Who Watches Accounting's Watchdog?  

February 15, 2006

No one, says a just-filed suit. If the campaign against the Public Company Accounting Oversight Board gains traction, expect a major reworking of Sarbanes-Oxley


Who Watches Accounting's Watchdog?

By Amy Borrus


Ever since Congress created the Public Company Accounting Oversight Board (PCAOB) in 2002, business executives and free-market groups have groused that the accounting-industry regulator wields too much unchecked power. Now, a free-market advocacy group and a small accounting firm are poised to take that complaint to court. Advertisement


On Feb. 7, the Free Enterprise Fund joined Beckstead & Watts, an accounting firm based in Henderson, Nev., to challenge the constitutionality of the PCAOB in U.S. district court in Washington.


"UNACCOUNTABLE, UNCONSTITUTIONAL."  The complaint turns on two points. One is the assertion that the PCAOB exercises wide-ranging governmental powers with little oversight, violating the Constitution's separation of powers. The second issue deals with how five members of PCAOB are appointed.


"The PCAOB is an unaccountable, unconstitutional regulatory body," says Mallory Factor, chairman of the Free Enterprise Fund. "It's the poster child for the dangers of a runaway bureaucracy."


But the larger goal of the lawsuit, Factor says, is to force Congress to reopen Sarbanes-Oxley (SOX), the corporate reform act that created the board. "The lawsuit puts a gun to [Congress'] head and says 'you've got to deal with it,'" Factor says.


If the PCAOB is found to be unconstitutional, a process that could take months, if not years, the court would leave it up to Congress to fix that portion. If Congress fails to act, the entire statute could be at risk because Sarbanes-Oxley lacks "severability" -- a provision, standard in most laws, that says that a judicial ruling striking down one portion of the law doesn't affect the rest of the statute.


DOWN WITH SOX?  Legal scholars say that, as a practical matter, much of Sarbanes-Oxley -- including tough criminal penalties for wrongdoers, a ban on company loans to executives, and rules requiring CEOs to certify financial reports -- could survive intact. But if and when Congress reopens the law, it could create an opportunity for wholesale revision.


Business groups could be counted on to lobby hard to weaken many provisions. Already, says Rep. Mark Kirk (R-Ill.), "there is a bipartisan concern over Sarbanes-Oxley and its effect on small business" because of the cost of compliance with the law.


PCAOB spokeswoman Christi Harlan declined to comment on the suit. "After the board and counsel have had an opportunity to examine the lawsuit, the board will respond appropriately," she said.


The assault on Sarbanes-Oxley will be argued by a bevy of high-powered legal eagles, including Ken Starr, a former independent counsel who headed the Monica Lewinsky investigation during the Clinton Administration, and Viet Dinh, a former U.S. assistant attorney general for legal policy during President George W. Bush's first term. The lead attorney is Michael Carvin, a partner at Jones Day and a former Justice Dept. official in the Reagan era. Two lawyers with the Competitive Enterprise Institute, a libertarian think tank, are also serving as plaintiffs' attorneys.


PRIVATE POWER.  The heart of the argument, says Carvin, is whether the process for selecting PCAOB members violates the appointments clause of the U.S. Constitution. That provision requires that top federal officials be appointed by the President and confirmed by the Senate; lower-level functionaries must be selected by the President, the courts, or a department head. Under Sarbanes-Oxley, the Securities & Exchange Commission, rather than the President, appoints PCAOB's members.


That violates the Constitution, Carvin says. While the law refers to PCAOB as a private corporation, it operates just like a governmental agency, making it subject to the appointments clause, Carvin argues. "People exercising this kind of independent authority should be appointed by the President and confirmed by the Senate," says Carvin.


Even if the board members were considered lesser officials, their appointments fall short of the Constitution, the complaint contends, because the SEC isn't a Cabinet-level department and because the full five-member SEC, rather than its chairman, makes the selection.


The SEC, which was not named as a defendant in the suit, declined to comment on the filing.


OLD STORY.  The arguments, however, aren't new. Constitutional scholars in Congress and universities considered them when Sarbanes-Oxley was being drafted in 2002 and determined that the law's appointment process was constitutionally sound. A Congressional Research Service review found that the board members were lesser officials because the SEC had final say over all important aspects of their work. CRS also said that earlier Supreme Court opinions indicated that agencies like the SEC could appoint such officials.


That view was endorsed in a June 17, 2002, letter to Sen. Paul S. Sarbanes (D-Md.), then chairman of the Senate Banking Committee, from Harvard Law Professor Elena Kagan. Kagan wrote that "the structure created... suffers from no constitutional infirmity" under the appointments clause as interpreted by the Supreme Court.


Sarbanes received similar reviews from law professors at the University of Michigan and Columbia University. "We're not worried about it," says a Senate staffer who has been briefed about the lawsuit.


TOUGH CHALLENGE?  Congress created the PCAOB in the wake of big financial frauds at Enron and WorldCom to police the accounting profession and prevent further corporate scandals. The final bill to create the oversight board passed 99-0 in the Senate and 423-3 in the House. "The PCAOB is at the heart of Sarbanes-Oxley and has been terribly important in cleaning up problems in the accounting profession," says former SEC Commissioner Harvey J. Goldschmid. "I believe the challenge to it will be rejected in the courts."


Still, the question of whether a collective agency can appoint lesser-ranking federal officials is not a settled matter. And a court might consider the PCAOB members high-ranking after all, by virtue of their pay -- upwards of $450,000 a year. "Their pay and the fact that they set their own budget and Congress has no power of the purse over them suggests that they could be considered principal officers," says Hans Bader, a legal expert at the Competitive Enterprise Institute.



-- Sucheta Dalal