- Supreme Court Strikes Down Part of Sarbanes-Oxley Act
- July 28, 2010 | Author: Bruce J. Douglas
- Law Firm: Larkin Hoffman Daly & Lindgren Ltd. - Minneapolis Office
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.