Watching Corporate Auditors

July 18, 2010

When Enron and WorldCom collapsed after years of uninterrupted flowing audits by accounting firms, Congress enacted the Sarbanes-Oxley Act.  The act created a non-profit commission to regulate auditors.  The Supreme Court has upheld the constitutionality of the Act.

In Free Enterprise Fund v. Public Accounting Oversight Board, the Enterprise Fund attacked the constitutionality of the act on the basis that the board’s setup violated the separation of powers doctrine by giving executive responsibilities to officials beyond presidential control.  The Supreme Court ruled board members were too insulated from removal by the president.  However, instead of throwing out the board or of invalidating the Sarbanes-Oxley Act, the Court struck down only that part of the Act that provided the Securities and Exchange Commission needs good cause to remove board members.  Therefore, the Court ruled, the S.E.C. may remove board members at will, i.e., without regard to good cause.

“The consequence is that the Board to function as before, but its members may be removed at will by Commissioners,” Chief Justice John Roberts wrote.  He was joined by Justices Antonin Scalia, Clarence Thomas, Anthony Kennedy, and Samuel Alito in a 5-4 decision.

The opinion focused on the “unitary executive” theory that proposes Congress should not have the power to protect agencies responsible for executing the law from presidential control.  In this case, the S.E.C., not the president, could remove members of the board and only for cause.  The president can remove S.E.C. commissioners, but only for cause.  The Court ruled that double insulation violated the principle of separation of powers.

“The constitution that makes the president accountable to the people for executing the laws also gives him the power to do so.  That power includes, as a general matter, the authority to remove those who assist him in carrying out his duties.  Without such power, the president could not be held fully accountable for discharging his own responsibilities; the buck would stop somewhere else,” wrote Justice Roberts in the majority opinion.

A dissent written by Justice John Paul Stevens said supervision of the accounting board “violates no separation-of-power principles.”  The dissent went on.   “I still see no way to avoid sweeping hundreds, perhaps thousands of high-level government officials within the scope of the court’s holding, putting their job security and their administrative actions and decisions constitutionally at risk.”  The dissent said among them were the leadership of the Nuclear Regulatory Commission, the Social Security Administration, administrative law judges and military officers.

The Board, although established by Congress, is not a government agency.  It does not have to follow pay schedules, so board members are paid $500,000 a year.

The Sarbanes-Oxley Act requires any auditor who audits a company that sells securities on the public market in the United States be registered.  Some foreign firms are included when they are involved in auditing foreign branches of American firms or audit foreign firms that list securities in the United States.  Certain countries have not consented to allow inspections of auditing firms located in their countries, including China, the European Union and Switzerland.  The board has been able to perform joint inspections in some countries of the European Union, but these ceased last year when sharing information became a problem.  Congress may need to amend the law to allow document sharing with foreign boards.  The financial regulation bill just passed by a joint Senate-House committee provides expansion of the requirement for auditing to include accounting firms which audit registered brokers, regardless whether the firm has public clients.

When the Act was passed, complaints abounded about the expense of companies assessing their management controls and that auditors give their opinion about those controls.  This sentiment has shifted now, thanks to reduction of the costs of the audits by the board.  Many corporate executives believe the benefits of compliance were greater than the costs.