Supreme Court Will Decide Constitutionality of PCAOB

The US Supreme Court has agreed to hear an audit firm’s challenge to the constitutionality of the PCAOB. 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. The case will be briefed over the summer and argued in the fall when the Court convenes for the 2009-2010 term. (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.

The US Court of Appeals for the DC Circuit, by a 5-4 vote, denied full or en banc review of the split panel decision. Given the fact that four circuit judges wanted a full review of the constitutional issues surrounding the Board’s creation made it almost certain that Supreme Court review would be sought. The full circuit court denied the rehearing en banc in a one page order, with no written opinions. Judge Kavanaugh, who dissented in the panel opinion, would have granted review. He was joined by Circuit Judges Ginsburg and Griffith, and Chief Judge Sentelle. Voting to deny full court review were Judges Brown and Rogers, who were the majority on the panel decision, and Judges Henderson, Tatel, and Garland.

In the federal district court, seven former SEC chairs, including William Donaldson, Arthur Levitt, Harvey Pitt, David Ruder, and Roderick Hills, filed an amicus brief defending the PCAOB as constitutional. The former chairs described the PCAOB as being squarely within the historical structure of federal regulation of the capital markets, which has relied for decades on a unique combination of public-private institutional relationships under SEC oversight. The Board exists, maintained the former SEC heads, because of a Congressional conclusion that the system of profession-dependent self-regulation of auditing contributed to the corporate financial scandals of the recent past. And nothing in the federal Constitution denies Congress the power to make the policy judgments reflected in the legislative design of the PCAOB-SEC relationship, according to the brief.

For its part, the SEC has consistently and vigorously defended the PCAOB against this constitutional attack on the appointment process of Board members and the manner in which the Board conducts its operations. In a joint brief in the district court with the Justice Department, the SEC contended that the method detailed in Sarbanes-Oxley for appointing Board members satisfies the Appointments Clause. In addition, the brief said that the pervasive authority of the SEC to supervise and control the PCAOB’s activities refutes the depiction of the Board as a rogue agency running unchecked over the separation of powers. Also, the Commission said that the Board’s performance of diverse functions pursuant to a variety of intelligible principles defeats the argument that Sarbanes-Oxley unconstitutionally delegated legislative power to the Board.The main government argument before the Court 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 government’s 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.

Taking square aim at the Government’s argument that an audit firm challenging the PCAOB’s constitutionality in federal court failed to exhaust its SEC administrative remedies, the firm told the Supreme Court that it would not invent a fictional controversy with the SEC solely to create a vehicle to challenge the Board’s constitutionality. In its reply brief to the Government, the audit firm said that no case has ever hinted that a standard provision for appellate review of agency rulemaking is the exclusive vehicle for challenging the agency’s, much less another agency’s, constitutionality, thus displacing a federal district court proceeding for injunctive relief. The firm urged the Supreme Court not to allow the Board to convert the most important separation-of-powers case in the last 20 years into a narrow dispute.

In its reply, the audit firm described as disingenuous the Government’s suggestion that it should have challenged a Board sanction because the Board’s investigation of the firm did not result in sanctions. Even more disingenuous, said the firm, is the assertion that it could have brought the challenge by seeking SEC review of the Board’s inspection report on the firm or petitioning the SEC to modify or revoke the Board’s authority, because appellate courts have no jurisdiction over SEC inspection report rulings or refusals to initiate rulemaking.


Moreover, the firm argued that the SEC’s views on the constitutional issues before the Court are not entitled to deference, adding that the Commission lacks institutional competence and authority to opine on separation of powers or invalidate the Board. And, pointed out the firm, the Commission in the lower courts and before the Court, has provided, in the United States briefs it joined, its construction of the Act, just as it would have done in a statutory review case.