The End of SarbOx? The Supreme Court Weighs In.

Silicon Valley says it's href="">killing
innovation. Financial executives claim it has ruined their ability to
recruit top board members. Public companies say complying with it requires href="">millions of
dollars in additional audit fees. When Congress passed the href="">Sarbanes-Oxley
Act in 2002, it was one of the most sweeping and controversial pieces of
business legislation since the 1930s. Almost eight years later, the law is up
for debate again, this time in the Supreme Court.

The case in brief:

After scandals at Enron and WorldCom, Congress responded
with SarbOx, a regulation overhaul designed to crack down on fraudulent
accounting. The law created stricter financial reporting rules for public
companies, and established the Public Company Accounting Oversight Board to regulate

Ever since SarbOx passed, however, plenty of businesses have
railed against it, complaining that href="">compliance
is too complicated and too costly.

On Dec. 7, the court will hear the case of Beckstead and
Watts, a small auditing firm in Nevada that claims a SarbOx investigation
ruined its business. In 2006, the company along with the Free Enterprise Fund,
a free-market advocacy group, filed a suit against the Oversight Board. Their
aim is to undo SarbOx by attacking the constitutionality of the board, which is
appointed and overseen by the SEC. The crux of their argument: Only the
president has the power to oversee such an executive-level body.

"There's certainly a group of securities professors, including myself, who
applauded Congress' decision to create a new regulator," says Donna Nagy,
a law professor at Indiana University who wrote a brief in support of the
Fund's argument. But, she says, Congress gave the board too much power without
imposing enough accountability.

The board defends its structure, arguing that the president has never had an
unfettered right to remove agency employees.

President Bush signs Sarbanes-Oxley Act in 2002
President Bush signed the Sarbanes-Oxley Act in 2002.
Source: George Bush White House Archives

Why it matters:

If the court deems the board unconstitutional, it’s
possible that the decision wouldn’t just alter part of SarbOx; it
could dismantle the whole thing — and in the process reopen a
contentious policy debate.

In a brief that supports the Free Enterprise Fund’s
argument, Ilya Shapiro of the nonpartisan, free-market leaning Cato Institute
argues that Congress passed SarbOx too quickly in a climate of panic. One of
the bill’s own sponsors, Rep. Michael Oxley, R-Ohio, said at the time
that it could grant the board powers that were “extraordinary and
maybe even beyond constitutional.”

The board’s extraordinary power, says Shapiro, has
created incentives for out-of-control spending, a lack of communication between
regulatory agencies, and confusion abroad amongst companies and foreign
regulators. “A lot of companies that were thinking about going public
in the United States have opened up in London instead,” he says.

If the court rules that the board — and therefore
significant portions of the law — is unconstitutional, then it would be
up to Congress to construct an oversight system that does not interfere with
the president's authority. Congress could amend SarbOx to make the board more
like a traditional regulatory agency, or redesign it as a unit within the SEC,
says Nagy. Or it could completely “reexamine Sarbanes-Oxley as a
matter of policy and legislation,” says Shapiro. Such a move would
require companies to learn a whole new set of accounting rules.

The outcome could have broader implications, too, especially
for the href="">financial
regulatory reform bill moving through Congress. Sen. John Cornyn, R-Texas,
has already used the basis for the Fund’s argument — that
high-level agency employees need to be appointed by the president and confirmed
by the Senate — to challenge President Obama’s appointment
of White House “czars” that oversee everything from
executive compensation to the auto industry. Similar challenges to other
regulatory bodies, both existing and proposed, could follow if the Fund wins
its case.

Other cases to watch:

  • Corporate fraud: Is the language that helped take down Conrad Black and Bernard Madoff too broad?

  • Campaign finance: Do corporations have the right to free speech when it comes to politics?
  • Botched pension plans: Who determines how much retirees get?

  • Patent law: Is it outdated in this digitally driven, idea-oriented era?