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These Men Could Kill SarbOx

Thursday, November 19, 2009 - 00:00
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From the marbled corridors of Congress to the tony salons of Georgetown, liberal lawmakers are abuzz with ideas on how to rein in U.S. corporations. Yet over in the courts, two conservative lawyers are mounting a serious challenge to a law, enacted earlier in the decade, that imposed tough restrictions on American businesses. A ruling in their favor could deal a serious blow to the pro-regulatory movement in Washington.

Michael A. Carvin and Noel J. Francisco, partners at the giant law firm Jones Day, are taking on the Sarbanes-Oxley Act of 2002, the controversial anti-fraud legislation passed after the last big wave of corporate scandals. The two are representing Brad Beckstead, the head of a small auditing firm in Henderson, Nev., who is suing the Public Company Accounting Oversight Board, the panel created by SarbOx to make sure auditors are doing their jobs. Beckstead says the PCAOB picked apart his business in a grueling 2004 audit. "I became the poster boy for what not to do when auditing small companies," he says. The cost of complying with the rules was so great, he claims, that he had to abandon his auditing practice.

On Dec. 7 the U.S. Supreme Court will hear oral arguments in the case, known as Free Enterprise Fund and Beckstead and Watts v. PCAOB and United States of America. A finding for Beckstead could reopen the entire Sarbanes-Oxley Act. Some board defenders fear a victory for Beckstead could even shake the foundations of established bodies such as the Federal Reserve. "The implications are potentially far-reaching," says Gillian Metzger, a Columbia law professor who is supporting the PCAOB board in filings with the high court.

For Carvin, 53, and Francisco, 40, this is no ordinary case. While the two have staked out a nice business for Jones Day cutting through regulatory tangles on behalf of blue-chip companies such as Electronic Data Systems (HPQ) (EDS) and R.J. Reynolds Tobacco (RAI), they're litigating Beckstead for free. They were attracted to the case not only for its potential to bring in new corporate clients but also because it fits their political agenda. "If you believe [in] limiting government, you're much more zealous," says Francisco.

Yet that passion hasn't alienated them from Democrats among Jones Day's 2,400 lawyers worldwide. One partner who voted for Obama says he enjoys jousting with the pair over politics. "Francisco has a beautiful mind," he says. "So does Mike."

CONSERVATIVE CONSORTIUMCarvin and Francisco are important players in what Hillary Clinton might call the vast right-wing conspiracy. They belong to an informal yet powerful web of conservative judges, lawyers, and veterans of the Ronald Reagan and George W. Bush Administrations that has been decades in the making. Even liberals admire the group's reach. "Although I disagree with these people to the core, I have a lot of respect for the way they went about cementing not just their beliefs, but the network of people who shared their beliefs," says Stephen Vladeck, an American University professor of constitutional law.

Both Carvin and Francisco boast impeccable conservative credentials, including big roles in Bush's successful challenge to Florida's Presidential vote in 2000. Francisco, a graduate of the University of Chicago law school, clerked for Supreme Court Justice Antonin Scalia. Perhaps most important, Francisco and Carvin—a law graduate of George Washington University—worked for the Office of Legal Counsel (OLC) under Reagan and Bush, respectively. The in-house law firm to the sitting Administration, the OLC's biggest job is scouring proposed laws and regulations for constitutional potholes—infringements of the President's appointment power, threats by one branch of government to encroach on another's authority, and attempts by executive branch agencies to overstep their bounds. OLC veterans include Supreme Court Justices Scalia and Samuel A. Alito Jr., as well as the late Chief Justice William H. Rehnquist, who was running the office when President Richard M. Nixon tapped him for the court in 1971.

Now the two are fashioning a "Republican OLC in exile," says John Elwood, a partner in the Supreme Court practice of the law firm Vinson & Elkins and a former OLC attorney. The OLC's focus on the Constitution and the balance between Presidential authority and Congress has long informed many of Carvin's and Francisco's arguments. Francisco is invoking the First Amendment in a bid to win Reynolds and other tobacco companies the right to promote chewing tobacco as a safer alternative to smoking. Similarly, when the government recently sought to slap tobacco companies with billions of dollars in penalties under federal racketeering laws, Carvin and Francisco successfully argued that the law didn't allow such penalties without criminal charges—effectively defanging the broader case. Carvin, meanwhile, represented EDS when it was a contractor for securities regulators and it botched the scoring of brokers' exams in 2005. Carvin argued successfully that Congress had protected the regulators—and therefore EDS, their contractor—when it established a comprehensive appeals scheme that precluded lawsuits seeking damages.


In Beckstead, Carvin and Francisco are taking on their boldest challenge yet. The PCAOB was established as an independent nonprofit largely to let it pay market wages for its workers rather than civil servant salaries and to shield it from political influence. In 2004 seven PCAOB auditors descended on Beckstead & Watts to pore over its practices. The result was a detailed report listing deficiencies based on the SarbOx rules. Beckstead penned a spirited response, but he says the cost of complying was too great and he had to shut down his auditing practices.

The Free Enterprise Fund, a conservative group founded by anti-taxation crusader Stephen Moore, took interest in Beckstead's plight. When the fund introduced Beckstead to Carvin, the accountant jumped at the chance to sue. (So did Carvin; he and Francisco agreed to stay with the case even after the fund ran out of money to support the litigation.)

Carvin and Francisco charge that the PCAOB is unconstitutional. They argue that the Constitution requires Presidential appointment of the top members of so powerful a body as the PCAOB. Yet, they point out, PCAOB members are appointed by the Securities & Exchange Commission. The lawyers also contend that PCAOB's members are largely beyond Presidential discipline because of a variety of restrictions on their removal. Since the Constitution requires the President to "take care that the Laws be faithfully executed," the President must have the widest possible power to remove those responsible for the government's executive functions, they say. The PCAOB argues that it is constitutional. Backers say its members are low-level officers who don't have to be appointed by the President, and say the President and the SEC have plenty of tools to govern the board.

A ruling for Beckstead could invalidate a host of post-Enron reforms. Because of a drafting quirk, the entire body of Sarbanes-Oxley might fall if a significant legal flaw is found anywhere within the legislation, say some attorneys. Other lawyers say a ruling for Beckstead could call into question the legitimacy of other regulators' appointments. For example, the fixed terms of the Federal Reserve's seven governors limit the President's ability to remove them—a situation that theoretically could be proved invalid if the court sides with the broadest arguments being made by conservative lawyers filing briefs in the Beckstead case.

But even a less sweeping opinion would probably give Congress time to fix the law so that it conforms with the Constitution. That would give critics a chance to reopen SarbOx to debate—and even make major changes. "You create tremendous advantages for the minority [party] to get substantial amendments," Carvin says. Separately, the House is considering exempting small companies from key provisions of SarbOx.

After the Beckstead case, Carvin and Francisco plan to turn their attention to the Obama Administration's aggressive reform agenda. "The stakes are enormous, and you have agencies getting into all kinds of areas they've never gotten involved in," Carvin says. The two lawyers are already talking with potential clients who fear losing millions in executive pay at companies receiving federal assistance, and they're pondering a challenge to various pro-union executive orders by President Obama. More cases are likely. Says Carvin, "it's a target-rich environment."

Francis is a correspondent in BusinessWeek's Washington bureau.