U.S. Supreme Court Unanimously Rules-- Sarbanes-Oxley Act “Remains Fully Operative as a Law”

The Supreme Courted voted unanimously to reject a challenge to the constitutionality of the Sarbanes-Oxley Act of 2002 (SOX). The case Free Enterprise Fund v. Public Company Accounting Oversight Board (PCAOB) raised the constitutional issues as to whether the PCAOB's structure complies with the Appointments Clause and the doctrine of separation of powers, in particular, whether SOX appropriately authorized the Securities and Exchange Commission (SEC) to appoint members of PCAOB rather than the President.

SOX was adopted by Congress to regulate the accounting industry as a result of the corporate scandals on Wall Street including the infamous Enron, WorldCom, Kmart, Global Crossing debacles, and others of their ilk, which exposed a wave of accounting chicanery used by certain publicly-traded companies to pump up their stock prices during the late-1990s through early-2000s bull market. In the aftermath of the accounting chicanery exposure, Congress sought to reform corporate America by creating, in essence, a federal corporate governance law. For centuries, corporate governance laws with the exception of securities laws, had been the exclusive purview of state legislators because corporations are creatures of state law not federal law. I recently published an article in the Encyclopedia of the U.S. Supreme Court, which analyzes the historical rulings of the Supreme Court regarding corporate law from 1880-2008. The article is available here.

Nonetheless, Congress overwhelming adopted SOX, which authorized the SEC to create an administrative entity that would regulate the accounting industry as it relates to publicly-traded companies, and the accuracy and truthfulness of financial disclosure to the general public. In response, the SEC created PCAOB to oversee the accounting methodology and disclosure of publicly-traded companies. Almost from its creation SOX has been vilified by many and beloved by many. Some commentator argued that SOX was too burdensome and expensive for publicly-traded multi-million dollars to adequately comply with its requirements. Still others argued that SOX did not go far enough regarding governance disclosure requirements, and as a result companies were not in compliance with the “spirit” of the law. In the words of Benjamin Franklin, it seemed as if SOX was the quintessential example of “laws too gentle are seldom obeyed, too severe seldom executed.”

Several legal commentators predicted that because SOX did not contain a severability clause, the Supreme Court would rule that SOX was unconstitutional. As such, Congress would be forced to re-enact SOX with amended provisions to address the severability and power to appointment concerns raised in Free Enterprise Fund v. PCAOB . In the alternative, Congress could simply return to the law, as it was before SOX was adopted. Professor Donna Nagy, C. Ben Dutton Professor of Law at the Indiana University Maurer School of Law, most recent scholarship on the PCAOB published in the PITTSBURGH LAW REVIEW entitled, "Is the PCAOB a 'Heavily Controlled Component' of the SEC?: An Essential Question in the Constitutional Controversy" raised interesting arguments regarding the PCAOB’s constitutionality. Professor Nagy’s article is available here. Additionally, Professor Nagy in collaboration with several law professors, submitted an amici brief to the Supreme Court in support of Free Enterprise Fund. The amici brief is available here. Despite legal commentators’ well argued positions, the Supreme Court disagreed. On Monday, the justices unanimously ruled that PCAOB has been legally established and appointed. There was a 5-to-4 split, but it concerned only the manner in which members of the PCAOB can be removed from office. As a result of the ruling, the SEC can remove PCAOB members at will, rather than being able to do so only if there were good cause that warranted removal. Chief Justice John G. Roberts Jr., writing the majority opinion stated that “the Sarbanes-Oxley Act remains ‘fully operative as a law’ with these tenure restrictions excised.”

With the issue settled, the SEC, under the direction of its chairwoman, Mary L. Schapiro, is expected to promptly act to fill three of the five seats on the PCAOB. SOX only authorized two of the five members could be certified public accountants — and both those jobs went to former SEC officials — Mr. Goelzer and Mr. Niemeier. Mr. Goelzer stated that the PCAOB was “pleased it would be able to carry out its important mission of overseeing public company audits in order to protect investors and promote the public interest.” Although, the PCAOB was established by Congress, it is not formally a federal government agency. As such it does not have to comply with federal pay schedules. PCAOB members are paid more than $500,000 a year. Not bad for an honest day’s work at the PCAOB.

Lydie Nadia Cabrera Pierre-Louis