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In 2001, the energy giant Enron unexpectedly filed for bankruptcy, laying off 4,000 of its employees and consuming the life savings of thousands more. In response to the public furor that followed, Congress passed the Sarbanes-Oxley Act, prescribing in minute detail the way American business must be managed and audited. The resulting red tape costs the American economy more than $35 billion per year. Ironically, many of the practices Sarbanes-Oxley imposes on American business, such as requiring corporate boards to be more “independent” of large shareholders and management, were present at Enron. The biggest beneficiaries of the law have been the big accounting firms that failed to warn the public about Enron and similar scandals, which are charging record fees to help businesses comply with Sarbanes-Oxley’s mountain of red tape. More importantly, Sarbanes-Oxley created an unaccountable bureaucratic agency that obscures fraudulent financial reporting by elevating form over substance. It set up a powerful new entity, the Public Company Accounting Oversight Board, to regulate the auditing of American business. The PCAOB has the power to fine accounting firms up to $2 million for even inadvertent violations of its rules, and its board is paid more than the president, receiving salaries of around $500,000 per year. In Violation But rather than focus on fighting fraud, the PCAOB has instead chosen to issue hundreds of pages of red tape governing companies’ “internal controls” that make auditing needlessly complicated. Auditors must now regulate such trivia as which low-level employee may have access to a company’s computer passwords. As a result, small public companies are finding it increasingly difficult to afford auditing, and many of the small accounting firms that audit them are going out of business. Despite its enormous power, the PCAOB is not responsible to our elected officials. Its members are selected collectively by the members of the Securities and Exchange Commission and are removable only for serious misconduct. That is a violation of the Appointments Clause of the Constitution (Article II, Section 2), which requires that federal officers be picked by the president and confirmed by the Senate, unless their authority is quite limited, in which case they can be picked by one of the president’s subordinates. Playing Games <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />
The PCAOB argues that its powers are not limited by the Constitution, because Sarbanes-Oxley declared it to be a private corporation, not a government agency subject to constitutional constraints. But the Supreme Court has rejected such word games, holding that nominally-private corporations like Amtrak that perform government functions are in fact government agencies that must obey the Constitution. It has also held that the Appointments Clause means what it says and that Congress cannot get around it by vesting the authority to punish in tribunals that are not appointed in the manner prescribed by the Constitution. The Appointments Clause the PCAOB violates is not a technicality, but a fundamental bulwark against government tyranny. As founding father James Wilson observed, by vesting appointments in a single executive branch official, the Appointments Clause makes him accountable for their performance, and encourages thorough vetting of the appointee’s qualifications. By contrast, when the SEC’s commissioners collectively voted to pick the first PCAOB chairman, the result was an embarrassing fiasco that led to his withdrawal and mutual finger-pointing. More importantly, the Appointments Clause promotes even-handed application of the law. A bureaucrat is less likely to abuse individual citizens if he knows he is accountable to their elected representative, the president. And he is more likely to stand up to vested interests that have lobbyists on Capitol Hill if he knows the president selected him and will back him up. The PCAOB, which is not accountable to any elected official, has not been even-handed. It has taken no meaningful action against any of the big accounting firms, even though its own inspections have revealed violations of accounting standards by all of them. Yet it has repeatedly disciplined small accounting firms for failing to exhaustively document the value of insignificant assets of small businesses. Thankfully, the days of the PCAOB’s wasteful regulation may be coming to an end. In February, the PCAOB was sued by two advocacy groups, the Competitive Enterprise Institute and the Free Enterprise Fund, and a small auditing firm that has been effectively forced out of business by the PCAOB’s red tape. The plaintiffs have asked the courts to declare the PCAOB unconstitutional under the Appointments Clause, and to block its board from creating any more red tape. End Of Enrons Hopefully, if the PCAOB is struck down, Congress will turn its attention to real reforms that actually protect shareholders, like preempting state laws that keep shareholders from kicking out corrupt or incompetent management or selling a mismanaged company to the highest bidder. That would require political courage, since big business has better lobbyists than its shareholders do. But unlike Sarbanes-Oxley, such reforms might actually prevent another Enron.