Last month, a three judge panel of the DC Circuit Court of Appeals heard oral arguments in Free Enterprise Fund, et al. v. Public Company Accounting Oversight Board, et al.. The lawsuit, originally filed in February 2006, alleges that the provisions of the Sarbanes-Oxley Act establishing the PCAOB are unconstitutional because those provisions violate separation of powers principles. With no separability clause in the Sarbanes-Oxley Act, a finding that one provision of the law is unconstitutional could bring down the whole Act. The pending appeal is from a March 2007 District Court ruling in favor of the PCAOB.
Based on the transcript of the oral argument, the focus of the Court was on the uniqueness of the PCAOB’s structure as essentially a government entity for constitutional purposes, but not a government entity for statutory purposes. While the appellants conceded the SEC’s role in overseeing the PCAOB’s rulemaking, they targeted their attack on the PCAOB’s allegedly unchecked enforcement and inspection function. In addition, the Court focused its questioning on the “for cause” requirement for removal of PCAOB Board members (as opposed to an at will removal standard), which is likewise the standard for removal of SEC Commissioners and thus puts the PCAOB’s leadership two “for cause” steps away from the President. While the government argued that the PCAOB was built around the self-regulatory organization model, the appellants (and the Court) pointed out the significant distinctions with the PCAOB, principally in that its board is appointed by the SEC and board members are only removable by the SEC for cause.
While it is certainly difficult to tell solely from the oral argument, this case may not be a slam dunk for the PCAOB and the government. Certainly the consequences of a ruling against the PCAOB are difficult to imagine – reopening the PCAOB and all of Sarbanes-Oxley at this point would undoubtedly be a bad idea.
In this commentary, Jonathan Weil of Bloomberg points out the views expressed during the oral argument by Judge Kavanaugh, who was by far the most vocal of the three judges on the panel.
LIBOR on Shaky Ground
I can’t think of anything more ubiquitous as a benchmark in financings and derivatives than the London Interbank Offered Rate (LIBOR), which has come under attack in the last few months for being out of synch with market developments. Yesterday’s WSJ featured an interesting article on the problems with LIBOR and some data suggesting how far out of whack LIBOR has become. Later today, the British Bankers Association will announce plans to make the first changes to LIBOR in over ten years.
Before becoming a lawyer, I managed assets and liabilities for a bank, and I can recall anxiously awaiting for the moment shortly after 11:00 a.m. London time when the BBA would post the day’s LIBOR and it would pop up on my Telerate screen. I always envisioned a bunch of guys in bowler hats (kind of like the bankers in Mary Poppins) drinking tea and setting the daily rates, but in reality, the BBA surveys its 16 member banks on how much it would cost them to borrow from each other for 15 periods ranging from overnight to one year (in currencies including dollars, euros and yen), and then averages the results of that survey data. Always taking the numbers as gospel, it never occurred to me that LIBOR’s reliability could ever be called into question, given the tendency of any survey and average to potentially distort reality. Notably, the WSJ article indicates that during times of market turmoil like we have faced in the past several months, banks have an incentive to avoid submitting rates to the survey that are higher than those submitted by their peers, lest they signal financial problems or desperation. This incentive tends to force the rates used to compute LIBOR to cluster together. This trend is perhaps confirmed by the fact that when the BBA threatened a month ago to ban from the survey any banks that misquoted their rates, the three month rate shot up 18 basis points over the next two days.
I doubt that the current troubles with LIBOR will push too many players to other benchmarks, particularly given how entrenched LIBOR is in the US and abroad. There are of course other alternatives for benchmarking short-term rates, such as the US Fed Funds rate. The principal difference between LIBOR and the Fed Funds rate is that while LIBOR is based on survey data, the Fed Funds rate is a target interest rate fixed by the Federal Open Market Committee and implemented through the open market operations carried out by the New York Federal Reserve.
2008: The Year of the Hedge Fund Activist
– Dave Lynn