The Supreme Court on Monday struck down part of a law to prevent fraud committed by companies like Enron and WorldCom, saying a board to police public companies' auditors violated the Constitution.
But the ruling left the 2002 Sarbanes-Oxley law and the Public Company Accounting Oversight Board largely intact, limiting the decision's impact on government efforts to curb corporate wrongdoing.
The Sarbanes-Oxley Act dodged a bullet and victory can be declared by the PCAOB and the proponents of Sarbanes-Oxley, said Jim Cox, a securities professor at the Duke University School of Law.
The court ruled 5-4 that the Public Company Accounting Oversight Board, known as the PCAOB, violated the Constitution because it does not give presidential administrations enough power to remove board members. The court ruled that the U.S. Securities and Exchange Commission should have the power to fire the board's members.
But the court held that the unconstitutional provisions can be separated from the rest of the law -- effectively keeping lawmakers and lobbyists from tinkering with the rest of Sarbanes-Oxley.
The SEC, the PCAOB, investors and the auditing community applauded the Supreme Court's decision.
The PCAOB has played a vital role in improving the quality of public company financial reports, said the Council of Institutional Investors, which represents investors with more than $3 trillion in assets. Shareowners depend on fair, accurate financial statements in making investment decisions.
The ruling comes as lawmakers prepare to vote on the biggest overhaul of financial regulation since the 1930s. Congress hopes to send the legislation to President Barack Obama to sign into law by July 4.
Supporters of Sarbanes-Oxley feared that a broader Supreme Court ruling would force Congress to revisit the entire act in order to keep the PCAOB functioning.
The legislation before Congress already waters down part of Sarbanes-Oxley, by exempting small companies from complying with a part of the 2002 corporate reform law.
At stake in the Supreme Court case was how corporate America is audited.
The board, set up as a quasi-private agency, has the power to impose rules and to inspect and fine accounting firms.
The board is funded through fees it collects from public companies. It inspects thousands of auditors, including the Big Four accounting firms: Ernst & Young LLP, KPMG, PricewaterhouseCoopers and Deloitte & Touche LLP.
The Free Enterprise Fund and a small Nevada accounting firm sued in 2006, arguing the law unconstitutionally stripped the president of power to appoint or remove board members or to supervise their activities. A federal judge and a U.S. appeals court rejected the challenge.
The Supreme Court's majority opinion by Chief Justice John Roberts said the limits on the removal of board members violated the separation of powers requirement.
Writing for the four liberal dissenters, Justice Stephen Breyer said the court's holding threatens to disrupt severely the fair and efficient administration of the laws.
The Obama administration and the board's attorneys had urged the Supreme Court to uphold the law. Defenders of the law said it helped restore investor confidence in the stock market and had improved the quality of corporate audits.
The law forced companies to disclose more information, required managers to sign off on financial statements and imposed audit requirements on firms. It has been criticized for driving up business costs and making the United States a less-attractive location than some other global markets.
The accounting industry used to regulate itself and was criticized for weak standards and enforcement, as well as potential conflicts of interests because private regulators were dependent on industry for funding.
The Supreme Court case is Free Enterprise Fund v. Public Company Accounting Oversight Board, No. 08-861.
(Reporting by Rachelle Younglai and James Vicini. Additional reporting by Emily Chasan in New York. Editing by Robert MacMillan.)