On June 28, 2010, the United States Supreme Court issued its
first decision concerning the Sarbanes-Oxley Act: Free
Enterprise Fund v. Public Accounting Oversight Board. At issue
was the constitutionality of the board Congress created to oversee
independent audits of publicly traded companies, the Public Company
Accounting Oversight Board ("PCAOB"). In a 5-4 ruling,
the Supreme Court determined that the Sarbanes-Oxley Act's
provision relating to how members of the PCAOB are removed violates
the Constitution because the removal process is too insulated from
presidential control.
The Sarbanes-Oxley Act ("SOX"), which Congress enacted in
July of 2002, introduced significant changes to the regulation of
corporate governance. Congress enacted SOX in response to the
Enron, WorldCom, and other business scandals, intending to combat
fraudulent accounting practices and other conduct defrauding
shareholders.
One important provision of SOX is section 404, which requires an
independent audit of virtually every public company's
internal controls on financial reporting. To monitor and tighten
oversight of internal corporate controls and outside auditors,
Congress created the PCAOB, a private, nonprofit corporation. The
PCAOB has the power to compel documents and testimony from
accounting firms, and the authority to discipline
accountants.
Under SOX, the Securities and Exchange Commission ("SEC")
appoints five members to the PCAOB and has oversight authority over
the PCAOB, including the approval of the PCAOB's rules,
standards, and budget. The SEC cannot, however, remove PCAOB
members at will; the SEC can only remove PCAOB members "for
good cause shown," in accordance with specified procedures.
Similarly, SEC commissioners cannot be removed by the president
except for "inefficiency, neglect of duty, or malfeasance in
office."
Petitioners argued that SOX contravened the separation-of-powers
doctrine by conferring wide-ranging executive power on PCAOB
members without subjecting them to presidential control. In fact,
PCAOB members were insulated from presidential control on two
levels: PCAOB members could only be removed by the SEC for good
cause; SEC commissioners, in turn, could only be removed by the
president for good cause. The Supreme Court agreed, holding that
the dual for-cause limitations on the removal of PCAOB members is
unconstitutional under the separation-of-powers doctrine.
Specifically, it found that the dual for-cause arrangement
contradicts the Constitution's vesting of the executive
power in the president.
The Court also found that the provisions containing the
unconstitutional removal restrictions are severable from the
remainder of SOX. Although SOX does not contain a severability
provision (a provision that allows one part of a law to be struck
down while keeping the other provisions in force), the Court noted
that the unconstitutionality of a part of an act does not
necessarily defeat or affect the validity of its remaining
provisions. The Court emphasized that only the removal restrictions
violated the Constitution, not the PCAOB's existence. With
those removal restrictions excised, the rest of SOX "remains
fully operative as a law," Chief Justice Roberts wrote for the
majority, since the remaining provisions are not "incapable of
functioning independently."
The consequence of this decision is that the PCAOB may continue to
operate as before, but now its five members may be removed at-will
by the SEC. The remainder of SOX lives on.
Please contact your Larkin Hoffman attorney if you require
additional assistance on this Supreme Court decision or
Sarbanes-Oxley Act compliance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
