In 2002, Congress passed a law aimed at punishing corporations for publishing false information in their financial statements. Regrettably, the future of this law, known as the Sarbanes-Oxley Act (SOX), is now in jeopardy. An accounting firm has filed a lawsuit in a Washington DC federal court questioning the law’s constitutionality. This law is essential to the nation’s need for accurate and honest corporate reports and Congress could rescue SOX by revising it. This law is also important because employee shareholders and regular investors alike, rely on these statements when determining how much of their retirement savings to invest in particular companies.

Congress passed Sarbanes-Oxley in 2002 after the Enron and WorldCom frauds, which were accompanied by the Adelphia Communications, Global Crossing, HealthSouth, and Tyco International frauds, as well. During those years, the accounting industry was supposedly regulating itself for audit quality and integrity. In practice, accountants were working hand in hand with the corporate cheaters in return for lucrative consulting fees. Sarbanes-Oxley set up the Public Company Accounting Oversight Board (PCAOB) to create better corporate auditing standards and police their quality. It made other sensible changes, too, including enhanced requirements for auditing a company’s internal financial controls and insisting that chief executives and chief financial officers certify the financials as accurate. For instance, the law holds chief executives accountable for the accuracy of corporate reporting and sets out criminal sanctions and heavy fines for false reporters.

The legal challenge to PCAOB is technical, having to do with whether a corporation’s president rather than the Securities and Exchange Commission should appoint corporate board members. The plaintiff in the lawsuit, Beckstead & Watts, a small accounting firm in Henderson, Nevada, audits companies trading on the Over the Counter Bulletin Board Exchange. In 2004, PCAOB reviewed Beckstead’s audits and found that, in eight cases, the firm “did not obtain sufficient competent evidential matter to support its opinion on the issuer’s financial statements.” Beckstead disagreed, the board instituted formal proceedings against the firm, and a lawsuit was filed.

The lawsuit questions whether the PCAOB created by Sarbanes-Oxley to clean up the Enron-tainted auditing profession is constitutional. Beckstead asked the federal court to cease the accounting oversight board’s operations, upon holding a portion of the Act unconstitutional. If the federal court finds one of the acts’ provisions to be unconstitutional, the whole law is sidelined. That’s because the law lacks a “severability” clause.

In theory, Congress could respond just by changing the structure of PCAOB’s board. However, should Congress not act and the federal court does strike down PCAOB, it couldn’t come at a worse time for investors. The financial crisis linked to subprime loans left the valuation of trillions of dollars of securities in doubt. Nothing is more important to the functioning of American markets than ensuring that its hard-working citizens can trust the corporate financial statements that their retirement and savings accounts invest in and rely upon.

If the court supports PCAOB, Beckstead may appeal to the United States Supreme Court. With the makeup of the current Court, unfortunately this means that Sarbanes-Oxley still won’t be out of the woods. We will watch this case with great interest.

Source: The Washington Post

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