US court rejects charge against constitutional validity of Sarbanes-Oxley Act

A US federal appeals court yesterday denied a constitutional challenge to the 2002 Sarbanes-Oxley law that created the Public Company Accounting Oversight Board (PCAOB) to oversee the accounting industry after a wave of business scandals like Enron and WorldCom rocked finance capitals around the world. With this decision the court upheld a lower court's ruling from March 2007 that dismissed the Free Enterprise Fund's lawsuit, filed in February 2006.

The US Court of Appeals for the District of Columbia Circuit panel's 2-1 ruling rejected the argument by the Free Enterprise Fund that the PCAOB violates the American constitution's mandated separation of powers among the three federal branches. An attorney for the conservative plaintiffs' group said it planned to appeal ruling, either to the full appeals court or directly to the Supreme Court.

The pro-business Free Enterprise Fund has argued that the PCAOB - endowed with subpoena power and the authority to discipline accountants - breaches the separation-of-powers requirement because its five members aren't appointed by the president, cannot be removed by him, and US Congress does not control the board's budget.

Beckstead & Watts LLP, a small Nevada accounting firm, joined the Free Enterprise Fund as a plaintiff in the case. The PCAOB inspected the firm in 2004 for compliance with Sarbanes-Oxley and mounted a disciplinary investigation based on that review, which identified eight audits that said the firm didn't obtain sufficient evidence to support its opinion on its clients' financial statements.

The SEC and justice department defended the PCAOB, arguing in a legal brief that the accounting board's members are ''inferior officers'' eligible for appointment by officials other than the president.

The PCAOB is funded by fees paid by public companies. Its members are appointed by the Securities and Exchange Commission (SEC), an independent federal agency, with consultation from the Federal Reserve Board and the US Treasury Department. The SEC's five commissioners are appointed by the US President with Senate consent.

The Sarbanes-Oxley law "does not encroach upon" the constitutional requirement because the board members "are subject to direction and supervision of the (SEC) and thus are inferior officers not required to be appointed by the president," said the ruling by Judges Judith Rogers and Janice Rogers Brown.

However, the ruling wasn't unanimous. Judge Brett Kavanaugh dissented, writing that it was "the most important separation-of-powers case regarding the president's appointment and removal powers to reach the courts in the last 20 years." The PCAOB's structure "unconstitutionally restricts the president's appointment and removal powers," he wrote.

The SEC, in a statement said the board's existence is "vital to protecting investors and furthering the public interest." The body's chairman Christopher Cox called the ruling "welcome news for the (SEC), investors and US capital markets." The PCAOB said it was "gratified" by the decision.

Besides creating the PCAOB, the 2002 law required greater financial disclosures and increased the criminal penalties for securities fraud after the wave of business scandals that engulfed Enron Corp., WorldCom Inc., Tyco International Ltd. and other companies. The law could be invalidated if any of its sections are found to be unconstitutional. Opponents want it sent back to Congress for a revision.

Business interests, especially smaller public companies, have complained about the costs of complying with a key part of the Sarbanes-Oxley law: the requirement to file reports on the strength of their internal financial controls and fix any problems. They also assert that costs of compliance have driven companies to less-regulated markets overseas.