SEC Defends Constitutionalty of PCAOB Against Court Challenge

By James Hamilton, J.D., LL.M.

It is not often that a full-blown constitutional issue intrudes upon the world of federal securities regulation. But such has happened with the challenge to the way members of the Public Company Accounting Oversight Board are appointed. The PCAOB was created by the Sarbanes-Oxley Act to essentially oversee the auditing of the financial statements of public companies and the audit firms that perform this function. The main constitutional attack on the PCAOB is that its members, of whom there are five, are principal US officers who must be appointed by the President with senatorial advice and consent. Instead, Sarbanes-Oxley commands that the SEC appoint the Board members.

In a joint brief with the Justice Department filed in federal district court for the District of Columbia, the SEC contended that the method for appointing Board members satisfies the Appointments Clause of the federal Constitution because the members are inferior US officers who can be appointed by Heads of Departments. In this regard, the SEC casts itself as a Department, with the commissioners as heads.

The issue really boils down to whether the Board members are principal or inferior officers of the United States. The SEC makes a strong argument for the fact that the members are inferior officers who report to their superior, namely the SEC. To bolster this argument, the SEC emphasized that it has pervasive review power over every final legal action that the Board takes. In addition to appointing the Board members, the SEC approves the PCAOB’s budget and all the rules and standards the Board adopts. Further, since it does not have subpoena authority, the Board must seek issuance by the SEC of a subpoena. I think that this is a compelling argument.

Sarbanes-Oxley also gives the SEC supervisory authority over the Board’s regular inspections of audit firms. Since Sarbanes-Oxley overwhelmingly gave the SEC plenary control over the PCAOB, concluded the Commission, it follows that PCAOB members are inferior officers and the SEC’s appointment of them is constitutional.