Is Real Stimulus On the Way From the Supreme Court?

By Phil Kerpen
Policy Director, Americans for Prosperity

With the rest of Washington floundering trying to help the beleaguered economy, good news may be on the way from the unlikeliest of the branches of government: the United States Supreme Court. The Court today agreed to hear a case, Free Enterprise Fund vs. Public Company Accounting Oversight Board (PCAOB) that challenges the constitutionality of the Sarbanes-Oxley (Sarbox) law, a huge regulatory burden that has sent capital fleeing U.S. public capital markets and made it very difficult for companies to access equity financing, at a time when debt financing has largely disappeared. A Court ruling striking down Sarbox would be a huge shot of adrenaline for financial markets and could help start a genuine economic recovery.

The staggering costs of Sarbanes-Oxley bear repeating. An analysis by Ivy Xiying Zhang of the University of Rochester measured the total stock market impact of the law as costing over $1 trillion. Perhaps a third of that loss reflects direct compliance costs; the other hundreds of billions of dollars are a result of the economic inefficiencies created. Nobel Laureate Milton Friedman told the New York Sun a couple of years ago that Sarbox was the biggest problem facing the U.S. economy, noting that it tells entrepreneurs: "Don't take chances because down will come the hatchet. We're going to knock your head off."

Sarbox was a classic government overreaction, rushed hastily into law in the wake of the Worldcom scandal with little deliberation. It would be an amazing victory for freedom and free markets if it could be undone by the Court at the same time the political branches are repeating the mistake with ham-handed overreactions to the credit crisis.

The most onerous requirements are under section 404 of the act, which has been interpreted by the PCAOB as requiring full external audits of all internal control measures. PCAOB and the Big Four accounting firms have turned Sarbanes-Oxley into a full-employment act for accountants and auditors, in effect rewarding them for their failing in the corporate scandals.

Sarbox is unconstitutional, because there is a fundamental flaw in the way the PCAOB is constituted. Because it is appointed by the Securities and Exchange Commission, it violates the appointments clause of the Constitution, which says that appointments for principal officers can only be made by the president with the advice and consent of the Senate, and that even inferior officers can only be appointed by a court of be the head of an agency. The SEC has a head, its chairman, but the PCAOB appointment process is conducted by the commission collectively, not by its chairman. It's a pretty clear Constitutional violation.

This clause remains in full force; it is alive and well in modern Constitutional law, not a quixotic revival of a conservative vision of the Constitution. Lower federal courts have ruled against the FEF v. PCAOB appointments clause argument on narrow technical ground without addressing this core issue, which stands a good chance of prevailing at the Supreme Court. If it does, the whole Sarbox edifice would fall if Congress fails to rectify the Constitutional impropriety, because the law doesn't have a severance clause

Democrats, trying to show they aren't overly hostile to business, have talked a big game about Sarbox reform. Prior to taking over as House Speaker, Democrat Nancy Pelosi promised to reduce the burden of Sarbox for smaller public companies, while Republican leadership remained silent on the issue. Democratic Sen. Charles Schumer teamed up with New York Mayor Michael Bloomberg in 2007 to commission a studythat focused largely on reducing the burden of Sarbox.

Three years into Democratic control here in Washington, there has been no progress on reforming Sarbanes-Oxley. Wouldn't it be amazing if the Supreme Court ended up striking this turkey down and delivering some real economic stimulus?

Mr. Kerpen is director of policy for Americans for Prosperity. He can be reached through www.philkerpen.comand his free daily podcast is available here. Mr. Kerpen was the policy director of the Free Enterprise Fund when the FEF v. PCAOB case was originally filed.