Banking

Sarbanes Oxley: A lesson in design fundamentals

Bad, hasty design decisions cost big, no matter the industry. In this case, our elected officials have given the best example to date with Sarbanes-Oxley.

Good software architects know how important it is to get the basic details of an environment and to ensure they have captured the conditions of an environment that mandate full attention. The variables in a complex environment must be at least acknowledged before putting a large, governing system in place. Professionals in software know how important it is to (ahem) read the fine manual. There's a reason for that. The truth is bad, hasty design decisions cost big, no matter the industry, no matter the motive or justification. In this case, our elected officials have given the best example to date.

Most of us know how far-reaching and how arduous compliance with Sarbanes-Oxley (SARBOX) has been.

SARBOX was designed to protect investors from accounting fraud and abuse and ensured tighter security controls within IT. By law, regular audits are now a commonplace activity where those controls were not in place before the Act. There is much debate on whether or not SARBOX accomplishes what it intends to do. However, there is little argument on how important some of the activities directed by SARBOX are for companies, such as creating full audit logs of what happens to money or ensuring the CEO of a company actually signs the company's tax return being filed. Things like these are good, regardless of federal law telling us they are. Nevertheless, the way SARBOX is enforced apparently requires more scrutiny.

The Government on trial

Enter the defendant: Title 1 of 11 of SARBOX created the Public Corporate Accounting Oversight Board (PCAOB). As the name indicates, the PCAOB acts as the dark overlord of independent auditors tasked with auditing public companies and as the main enforcer of the mandates dictated by the Act. The Board, in turn, is held to task by the Securities and Exchange Commission (SEC)  but functions as an entirely independent agency free from political influence.  The PCAOB consists of five members who are appointed by the SEC. So, therefore the SEC is really ensuring federal compliance through a separate and independent company. Sounds good, right?

Wrong. The United States Constitution has a little thing to say about separation of powers.  In its Appointments Clause, all officers of the United States must be appointed by the President and are accountable directly to him. The Executive Branch reserves the right to appoint and remove the appointees as it sees fit. The Clause also dictates inferior officers must be appointed by Congress.

Enter the plaintiff: The Free Enterprise Fund raised this very point back in 2006.  If the SEC board governs the PCAOB, how is it constitutional? You see, the members of the PCOAB making decisions and enforcing law are not  appointed by the President, therefore they also cannot be removed by the President. The PCAOB's members are hired and removed by the commissioners of the SEC, not Congress. The fact the PCAOB is "private sector, not for profit" is also a sticking point. It means it is exempt from any Executive oversight. And here's the final rub: the SEC commissioners do not report to the SEC Chairman directly (meaning he is not the "head" of the organization), nor are the PCAOB members "directed or supervised" directly by the SEC. The PCAOB has wide-open license to  do whatever "may be necessary or appropriate in the public interest or for the protection of investors."

The Supreme Court

On December 7, 2009,  the Supreme Court agreed to hear this case. Beforehand, lower court Judge Brett Kavanaugh of the U.S. Court of Appeals for the D.C. Circuit stated, "...we have an independent agency whose heads are appointed by, and removable only for cause by,  another independent agency."  During the trial on the 7th, Justice Scalia made the same damning observation: "The President has adequate control over the SEC only because he can dismiss the chairman of the SEC. But the activity here is not governed by the chairman of the SEC," Scalia said. "The governance of (the PCAOB) is by the members of the SEC." With regards to the ability of the President to dismiss an appointee for cause, Justice Roberts remarked, "That's for cause squared and that's a significant limitation on the President's power that this court has not recognized before."

The cost of overzealous design

I'd say this is an important detail our elected officials should have caught and avoided in the early planning phase of SARBOX. It's the requirement: laws must be constitutional. Was the manner by which  the PCAOB was created simply an oversight in haste of delivering salvation to deceived investors everywhere? Or was it deliberately crafted in such a way to avoid the restrictions of the separation of powers doctrine? Regardless of motive or just sheer incompetence, the result is the same and the ramifications are staggering. Does this mean SARBOX itself falls apart? If one part of SARBOX is deemed unconstitutional, are there provisions within it to keep it from having to be completely re-crafted? Is there a contingency plan? If not, does that mean all fines or sanctions imposed up until this point can be challenged?  Chew on this: In the 1995 case Ryder v. United States, the Supreme Court ruled unanimously that "an individual firm disciplined by a government agency can challenge that discipline if agency officials were improperly appointed." Think about what that means for everyone working for a public company from July 2002 to now who ended up in the iron jaw of non-compliance. Kenneth Lay must be rolling over in his grave.

Final thoughts

Somewhere, someone should have asked the core question and ensured it could be answered without challenge: Does the passing of the Sarbanes Oxley Act and the enforcement agency it created abide by our country's framing document, the one by which all law must align? Even if the initial answer was no, this query officially hit the courts nearly 4 years ago before public view. Were no steps even taken then to address the question at hand? (Maybe put the SEC directly in charge of the overseeing the public company accounting practices?) Was it even considered the plaintiff might have a point?

The answer is obviously no, because doing so would do what this decision by the Supreme Court in June 2010 potentially has the power to do: dismantle the PCAOB and bring SARBOX down with it. At best, the way the PCAOB was created resulted from poor planning due to hasty reaction to investor hoodwinking. At worst, the PCAOB was created by Congress with the absolute intention giving it free-reign power with no accountability to the Executive Branch of our Government. Just like a poorly developed application, having no provision in the Sarbanes Oxley Act to survive if parts of it are deemed unconstitutional means it will crash and burn when that fatal flaw is exposed. It means the PCAOB will be enjoined from further activity until SARBOX is amended and passes through Congress again. This is more than a loophole or oversight, it's Epic Fail.

23 comments
amolden
amolden

Sarbanes Oxley is a huge, unnecessary tax being put on business. This puts domestic enterprise at an international competitive disadvantage. There are huge numbers of people who could be doing productive work, planning, executing and auditing the loosely written SOX mandate. Prior to SOX, there were plenty of laws on the books to prosecute financial fraud, they just needed to be properly enforced. There are also boards of directors that should oversee public companies. All corporations should internally ascribe to a code of ethics such as the one here: http://revoleader.com/5301.html.

The 'G-Man.'
The 'G-Man.'

The same document that is now so dated it is somewhat irrelevant in the modern day world!

ella2
ella2

could the president empower supreme court to appoint overseeing commitee within given parameters to ensure the appontees have the capacity and knowledge to execute there task- as regard to what has happened it is fait accompli Lets correct it nhkiriella@ gmail.com

erica.j.henson
erica.j.henson

One thing that didn't fit in the column was this: It's interesting to me that PCAOB is being challenged on "separation of powers" whereas companies must ensure compliance with the same kind of thing (e.g. "separation of duties"). Strikes me as ironic. :)

cook.erik
cook.erik

With all the things to complain about SOX you choose this?!

rcycan
rcycan

Consider also Federal Reserve Banks -- independent directors US Postal Service -- a corporation FDIC - independent directors FINRA - empowered by the US Govt to perform certain regulatory actions Moodys and similar, empowered to rate securities This will be an interesting decision.

wbranch
wbranch

This is why there should be a law that ANY legislation being considered by Congress should have as its FIRST section, a statement of where in the Constitution this law derives its justification. It would force those who write the law to think about the legality of new legislation and would make Constitutionality challenges very simple and straight-forward. Unfortunately you'll never see that happen because our legislators have no interest in following the Constitution. There have been Congressman and Senators who have been challenged on legislation such as Health Care "Reform" and where the Congress has the authority to write such legislation and their response has been that sure the Constitution doesn't authorize it, but hey we've passed other unconstitutional legislation before and no one's stopped us, so we can do it again. Government should be measured, slow and deliberate ESPECIALLY at the Federal level, that's the foundation of this country.

sboverie
sboverie

Congress tends to be sloppy at writing code. The purpose for SARBOX has a good intent in keeping company finacial information honest. One of the major problems with congress is it has failed to be a deliborative body and is a reactionary body. The Japenese Diet (legislature) considers about 100 bills per year; US congress considers thousands. Another part of the problem is a bill can be so complex that no one person understands it. Add on the riders and amendments and the complexity increases. When congress is reacting to a national crisis, they tend to move fast and skip over problems. This is why a good bill is hard to pass but a bad bill is impossible to change once it has become a law. Congress should aim at being more deliborative, considering only a small number of bills per year. The bill itself should be as concise as possible and written in simple terms to reduce loopholes and bad law execution. A bill should not have any unrelated riders or amendments attached; example: adding a bridge project to a health bill.

cartmit
cartmit

"Does the passing of the Sarbanes Oxley Act and the enforcement agency it created abide by our country?s framing document, the one by which all law must align?" Of course it doesn't. The Constitution is a specific enumeration of FEDERAL powers. It furthermore EXPLICITLY states that any powers NOT enumerated are reserved to the states or the people. Somewhere around 99.9% of the gargantuan body of federal law fails the test, yet we, the sheeple, properly groomed through public (government) "education" bleat compliantly and accept our chains.

prhodes
prhodes

You make the implicit assumption that the Constitution is important to our elected officials. The record of the past 10+ years amply demonstrates that it is not - getting re-elected is the only thing they care about for the most part.

MyopicOne
MyopicOne

Sarbanes-Oxley is an epic fail on more grounds than constitutionality due to inconsistency in which audits were conducted across accounting firms, because the accounting firms used it to inappropriately beat company IT departments senseless, and because the accounting firms used it as a revenue enhancer through the (often denied) injection of consultants. Good idea, very, very poor execution. Pretty much the norm for the USG the last couple of decades...

terry.floyd
terry.floyd

I beg to differ. And so would the ACLU.

ultimitloozer
ultimitloozer

Maybe you should actually read the document until you completely understand the contents of it before claiming that it is "irrelevant" in today's society.

mcrin
mcrin

Is a system of checks and balances irrelevant? Is the limiting of power to prevent the establishment of an aristocracy irrelevant? Not that I entirely agree with everything in the constitution (I would have been an anti-federalist back in the day), but it IS the framework for our system of government and is just as relevant today. The nature of man has not changed .

eclypse
eclypse

The document is absolutely not dated. In fact, the framers knew that it did not and would not cover every modern eventuality, but the principle of limited government is just as relevant today as ever - even though the greedy, no-good imbeciles that make up the government today try to act as though there are no limits to what they can do. I agree with one of the previous posters in saying that each new piece of legislation should have to show its constitutionality or be DOA.

erica.j.henson
erica.j.henson

I'd say this one is the biggie, even if the other things we "love" about SARBOX are more visible. :)

erica.j.henson
erica.j.henson

The whole thing is pretty fascinating to watch. During the trial on 12/7, Justice Kennedy asked the PCAOB attorney a question: "Are you encouraging the president, on an ongoing, daily basis, to instruct an independent agency what he wants done?" I have been following a few sites, including this one of a corporate law professor. It has more detail and a lot more legal-eze linked to it. There's even a 'vote forecaster' that predicts the outcome of the case. http://www.professorbainbridge.com/professorbainbridgecom/2009/12/pcaob-before-supreme-court.html

tmcclure
tmcclure

Unfortunately you can pretty much say Congress uses the "commerce clause" to justify their actions. The problem with your idea is Congress gets to make up their own definitions. We need Judges who are not swayed by political pressure and influence first.

blutarsky
blutarsky

H.R. 1359 and S. 3159 were introduced...and defeated. They each required just what you say: specific language pointing to the authority granted within the Constitution. So, what does it tell you when the majority has declared they don't want to be bothered by pesky things like the U.S. Constitution?

jmgarvin
jmgarvin

I mean honestly, can someone actually read and digest 2000 pages of law in the amount of time required to pass the bill?

NotSoChiGuy
NotSoChiGuy

...and along with common courtesy, it is one of the least common things found in this country! Not a single incumbent is getting my vote for the foreseeable future. Churn is the only way to make it clear that the people deserve & expect more.

tmcclure
tmcclure

Right on brother. You hit the nail on the head. It is funny the 60's generation is now in charge. In their youthful days they used to go around saying "down with the establishment." and "don't trust anyone over 30." What happened to that generation? LOL.

tmcclure
tmcclure

I go so far as to say the Constitution has been eroded since Teddy Roosevelt and the Progressive movement.

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