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

SEC v. Bank of America Round Two: Bank Of America Seeks To Pay $150 Million To Make The SEC Go Away

In September I posted a piece on the blog discussing Judge Jed Rakoff’s unusual rejection of a proposed settlement between the Securities Exchange Commission ("SEC") and Bank of America surrounding the solicitation of shareholder proxies to purchase Merrill Lynch & Co. The SEC alleged in its original Complaint that Bank of America failed to adequately disclose information relating to Merrill Lynch bonuses to shareholders as part of the acquisition. Well, as promised, my post today is an update designed to bring you up to speed on the SEC v. Bank of America litigation. At the outset, it should be noted that just about one month ago, in January, the SEC amended its Complaint to allege that Bank of America failed to disclose Merrill Lynch & Co.’s expected losses to shareholders.

On Thursday, February 2, 2010, Bank of America agreed to pay a settlement of $150 million to the SEC to dispose of claims that Bank of America misled shareholders in relation to bonuses and losses at Merrill Lynch. Again, this settlement is subject to the approval of United States District Court Judge Jed Rakoff. Recall, that in September 2009 Judge Rakoff rejected a proposed $33 million settlement between Bank of America and the SEC as unfair and unreasonable.

As part of the settlement, Bank of America would have to take a number of steps over the course of the next three (3) years to reinforce corporate governance and internal control measures. In a court filing on Thursday, in seeking Judge Rakoff’s support the SEC noted: “The relief contemplated by the proposed order is fair, reasonable, adequate and in the public interest…” Certainly, Judge Rakoff will have the final word. It will be interesting to see if Judge Rakoff decides to approve this current settlement proposal.

Two More Bernie Madoff Associates Arrested And Charged With Fraud

Bernie Madoff is in jail for 150 years for pulling off one of the most massive Ponzi schemes in history. One thing is certain: Bernie Madoff could not have acted alone to perpetrate his fraud. In recent weeks and months many of the people around Bernie Madoff have begun to fall.

In the latest episode, two of Bernie Madoff’s computer programmers were arrested on Friday in New York on charges of falsifying books and records and helping Madoff to pull off his fraudulent scheme. Jerome O’Hara, 46, and George Perez, 43, were charged with criminal conspiracy and accused of producing false documents and trading records for Bernard L. Madoff Investment Securities LLC. “O’Hara and Perez were accused of knowing that the special computer programs they developed contained fraudulent information used in U.S. and European regulatory reviews.”

The Securities and Exchange Commission also filed civil charges against O’Hara and Perez. The arrest of O’Hara and Perez brings to five (5) the number of people criminally charged in the Madoff Scandal. Hopefully, more arrests should be forthcoming.

Inspector General Issues Madoff Report: SEC Criticized For Investigatory Failure

Recently, the Office of Inspector General (“OIG”) issued a Report of Investigation into the Securities and Exchange Commission (“SEC”) failure to investigate and uncover Bernard Madoff’s Ponzi scheme. The Report finds that no SEC personal had any financial or other inappropriate relationship that hindered their investigatory duties. However, the Report openly criticizes the SEC for failing to adequately investigate six (6) separate substantive complaints that should have raised red flags concerning Madoff’s operation. Additionally, the OIG’s Report indicates that the SEC further ignored two (2) published articles that should have called Madoff’s operations into question.

The Report notes:

“The OIG investigation did find, however, that the SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six…substantive complaints that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading. Finally, the SEC was also aware of two articles regarding Madoff’s investment operations that appeared in reputable publications in 2001 and questioned Madoff’s unusually consistent returns.”

In face of all the red flags, the SEC clearly failed in its role as securities industry watchdog. The Madoff Report is interesting reading, and well worth the time and effort. At the end of the day, the OIG's Report chronicles how the SEC botched the investigation of Madoff, and postponed his day of atonement some sixteen (16) years.

Hopefully, the SEC has learned some valuable, albeit embarrassing lessons, that it won’t soon repeat. The lesson learned: Regulators don’t fall asleep on your watch the general public is relying upon you to do your job. To err is human. We all make mistakes. However, this has been one of the costliest mistakes resulting from a failure of oversight that we will hopefully see for some time to come.