Government Urges US Supreme Court to Reject Constitutional Challenge to PCAOB

The US Government has asked the Supreme Court to reject an audit firm’s petition to rule on the constitutionality of the PCAOB. The main government argument is that the audit firm failed to exhaust its administrative remedies before the SEC; and thus the federal district court lacked jurisdiction to entertain the claim that the creation of the Board was unconstitutional. Congress modeled the Board on the SROs, noted the brief, and the same judicial-review procedures for the SROs are applicable to the Board. Because the district court lacked jurisdiction, the Supreme Court could not reach the merits of the questions presented in the petition, argued the brief, even if review of those questions was otherwise warranted.

The audit firm asked the Supreme Court to declare the PCAOB unconstitutional because Sarbanes-Oxley Act provisions creating the Board violate the separations of powers and Appointments Clause by essentially stripping the President of all powers to appoint or remove Board members. In its petition, the firm argued that the Board is a congressional attempt to create a ``Fifth Branch’’ of the federal government over which the President has less control than over ``Fourth Branch’’ agencies like the SEC, which currently reflect the outermost constitutional limits of congressional restrictions on the executive. (Free Enterprise Fund v. PCAOB, Dkt. No. 08-861).

Upholding a district court ruling, a split federal appeals court panel decided that the PCAOB is constitutional and rejected claims that SEC rather than presidential selection of Board members violates the Constitution. The panel concluded that Board members are inferior officers of the United States within the meaning of the Appointments Clause; and thus properly appointed by the SEC. The fact that the Sarbanes-Oxley Act limited the SEC’s authority by providing that Board members can only removed for cause did not elevate Board members to the status of principal officers of the US worthy of presidential appointment. Despite the for-cause removal, said the panel, the fact remained that the Act gave the SEC comprehensive and pervasive control of the PCAOB, including the approval of the Board’s budget.

In its brief, the Government noted that, since the enactment of the Exchange Act, the federal securities laws have provided the exclusive mechanism for parties aggrieved by self-regulatory organizations to obtain judicial review. That procedure guarantees the SEC an opportunity to address the questions presented in an authoritative order or ruling, subject to direct review in a federal appeals court.

According to the Government, the audit firm was not free to disregard the statutory review process established by Congress and, instead, assert facial challenges in district court untethered to particular claims of injury. These jurisdictional defects are underscored by the firm’s implicit invitation to the lower courts to create a new cause of action on its behalf. The federal courts should not entertain requests to create implied remedies against quasi-governmental agencies when Congress has expressly provided a mechanism for judicial review.

If the firm had presented its constitutional challenges to the Commission, the federal courts would then have the benefit of the Commission’s authoritative construction of the Act. But by bringing their claims directly in federal district court, said the brief, the firm deprived the Commission of the opportunity to consider those arguments and, if necessary, to construe its own powers under the Act in light of the asserted constitutional defects.

Thus, the Court’s review of the questions that petitioners seek to pose is premature. If, in an appropriate future case in which a regulated person invokes the Act’s review procedures, the SEC interprets its statutory authority over the Board in such a way as to call the constitutionality of the Act into question, there would be time enough for the Court to review the relevant constitutional questions.

The government also addressed the substantive claims. The audit firm contended that members of the PCAOB are principal officers under the Constitution who can only be appointed by the President with the advice and consent of the Senate. In the government’s view, the court of appeals correctly rejected that claim, holding that Board members are inferior officers since they are in every respect subordinate to the SEC.

Further, the Commission’s authority over the Board is explicit and comprehensive. Indeed, it is extraordinary. Every auditing standard, ethics rule, or other rule or modification of a rule promulgated by the Board must be approved by the Commission. And no rule of the Board can become effective without prior approval of the Commission. If the Commission becomes dissatisfied with the operation of a Board rule in practice, it is empowered at any time to abrogate, add to, or delete from the rule as the Commission deems necessary.

The government also said that the creation of the Board did not violate the more general separation-of-powers principles. The court of appeals correctly explained that, given the constitutionality of independent agencies and the Commission’s
comprehensive control over the Board, the audit firm could not show that the statutory scheme so restricts the President’s control over the Board as to violate the separation of powers.