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SOX Under Fire

Ken Starr is the ultimate beltway insider. The former White House independent counsel is one of the most powerful attorneys in Washington, D.C., and as a former judge on the D.C. Circuit Court of Appeals, he knows a thing or two about what it takes to successfully challenge federal regulators.

The Starr factor is why the legal community is paying attention to a lawsuit that would otherwise seem like a shot in the dark--a suit aimed at taking down SOX. Along with powerhouse attorneys Michael Carvin (President Bush's counsel in the Florida ballot controversy) and Viet Dinh (a key figure in the development of the Patriot Act), Starr filed the suit Feb. 10 on behalf of a Nevada-based accounting firm and small-government advocates The Free Enterprise Fund. Specifically, the plaintiffs allege that the Public Company Accounting Oversight Board (PCAOB)--the agency charged with enforcing SOX--violates the Constitution's Appointments Clause and the constitutional separation of powers. Moreover, because SOX doesn't have a severability clause, the plaintiffs say that a win on the PCAOB issue means the court will have to invalidate the whole law.

While courts may not be too eager to tear down the house that Enron built, the lawsuit is only one battle in a many-pronged war that political heavyweights are waging against SOX. Some observers characterize the lawsuit as an attack meant to bolster the efforts of the Advisory Committee on Smaller Public Companies (ACSPC), which will recommend in April that the SEC offer relief from SOX to small public companies.

"You're starting to see the forces on either side of Sarbanes lining up for an all out political war," says Mike Tankersley, a partner at Bracewell & Giuliani. "We're watching the blow-by-blow unfold."

Constitutional Challenge

Essentially, the Starr lawsuit claims the PCAOB violates the Appointments Clause because the SEC selects its members without the approval of any elected official. The Appointments Clause requires that the president appoint with the advice and consent of Senate any "officers of the United States." Further, the suit claims the board violates separation of powers because it has executive, legislative and quasi-judicial functions.

"The PCAOB exercises core governmental authority without constitutional accountability," Dinh says. "PCAOB has the power to levy fees, to promulgate regulations with the force of law and to initiate enforcement actions."

Some observers, however, argue the SEC--the commissioners of which the president appoints--retains significant control over the PCAOB.

"Under Section 107 [of SOX], the SEC has the authority to approve all the board's rules and actions before they go into effect," says Terry Haines, a shareholder at Buchanan Ingersoll who served as counsel to Rep. Michael Oxley.

Further, many securities experts characterize the PCAOB as a lower-level agency, the members of which don't need to be appointed by the president.

"The PCAOB is analogous to the NASD and NYSE," says C. Evan Stewart, a partner at Zuckerman Spaeder in New York. "Those are very powerful semi-public agencies whose members aren't appointed by the president. No one's saying that's unconstitutional."

An ironic twist to the case is that it might be scuttled based on Morrison v. Olson, in which the Supreme Court held that the powers of the independent counsel--Ken Starr's previous job--didn't violate the Appointments Clause or separation of powers.

"Morrison recognizes that there are many inferior officers out there exercising executive and judicial functions in limited spheres that do not have to be appointed by the president," says Robert Ray, a partner at Kelley Drye & Warren.

Despite those hurdles, no one characterizes the suit as frivolous. And the new, more conservative High Court might give the constitutional argument more serious consideration. Still, the courts are unlikely to toss out the Act wholesale. The more likely outcome would be to give Congress a time frame within which to bring PCAOB within Constitutional boundaries. Observers note that if that occurs, Congress might re-examine other aspects of the law.

And some factors indicate that the political will for changes to Sarbanes-Oxley is building.

Change Is Good

In this election year, Congressmen looking to get in the good graces of small businesses may do so by taking another look at some of the more burdensome provisions of SOX.

"Small public companies are looking for some relief and they wield significant political power," Tankersley says.

In addition, Sen. Sarbanes and Rep. Michael Oxley are retiring at the end of their current terms, which means they won't be around to protect the legislation if Congress considers changes.

"I hope Congress will heed the call, including from some SEC commissioners, to re-evaluate the cost-benefit of the various provisions to ensure that the law directs the right solutions to the right problems," Dinh says.

But even if the courts toss Starr and his clients out the door, there is still pressure from other sources to make some changes to SOX that won't go ignored. The ACSPC will issue a new round of recommendations to the SEC in April. And if the past is any guide, the SEC will be receptive to its advice.

"The SEC takes [the ACSPC] quite seriously," Tankersley says. "When the committee recommended that the SEC put off the 404 compliance deadline for smaller companies, the SEC agreed to do so almost immediately."

Quick Fixes

According to a draft version of its recommendations released for public comment in February, the ACSPC is asking for fairly major changes to SOX requirements for smaller public companies.

Most significant among its proposals is the establishment of a two- or three-tiered system of securities compliance that would lessen the regulatory burdens on smallcap and microcap companies. Among other things, the changes would exempt microcap companies from 404 compliance; exempt smallcap companies from the external auditor requirement of 404; and require the Financial Accounting Standards Board to extend the effective dates for all new accounting standards for microcap companies to the same dates it imposes on private companies.

The ACSPC's definition of "microcap" comprises 52.6 percent of U.S. public companies, and its definition of "smallcap" comprises 25.9 percent of U.S. public companies. The ACSPC's recommendations would, therefore, exempt the vast majority of public companies from compliance with the most burdensome--and politically charged--provisions of SOX.

Although adoption of the ACSPC recommendations would not have as broad an impact on SOX as the success of Starr's lawsuit, the ACSPC may pave the way for future changes to SOX.

"'This costs too much' isn't an argument that wins in court," Stewart says. "But that's the subtext of the lawsuit. The SEC commissioners are receptive to discussing whether certain costs are necessary, especially for small companies."

Staff Writer

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