Supreme challenge for Sarb-Ox

The US Supreme Court has agreed to review a ruling by a US appeals court that upheld the constitutionality of the Sarbanes-Oxley Act of 2002. The case was originally brought by think tank the Competitive Enterprise Institute, representing advocacy group the Free Enterprise Fund and a small Nevada accounting firm. The case challenged the constitutionality of the appointment policies of the Public Company Accounting Oversight Board (PCAOB), which was created by the Sarbanes-Oxley Act in order to oversee the auditing of US public companies.

The PCAOB has broad powers to impose regulations controlling the auditing of all public companies. It supports itself with an accounting support fee that it levies on these companies. It also has the power to inspect, investigate and punish accounting firms and accountants for violating its regulations, professional standards or federal laws.

PCAOB members are appointed by the five members of the Securities and Exchange Commission. CEI argues in its suit that this structure violates the Appointments Clause of the Constitution, which provides that the President “shall nominate, and by and with the Advice and Consent of the Senate, shall appoint Ambassadors, other public Ministers and Consuls, Judges of the Supreme Court, and all other Officers of the United States, whose Appointments are not herein provided for … but Congress may, by Law, vest the Appointment of such inferior officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.” The term department has in the past been interpreted by the Supreme Court to mean a part or division of the executive government.

In seeking to prove that PCAOB members qualify as “Officers of the United States”, the case cites previous Supreme Court rulings that the ability to impose substantial sanctions makes adjudicators “Officers” even if they lack authority to enter a final decision. The suit also claims that PCAOB members have the “authority to formulate policy for the Government,” and their investigative authority covers an entire national industry, which they can investigate on their own initiative, rather than being limited to investigating a single case referred to them by a supervising body. Because PCAOB members hold these powers, they are certainly “inferior officers”, if not “principal officers”, the suit claims.

CEI argues that the SEC does not meet the Constitutional definition of a department, citing a Supreme Court decision to confine the term “Heads of Department” to executive divisions like Cabinet-level departments, whose heads are subject to the exercise of political oversight and share the President’s accountability to the people. Therefore, the appointments of all the PCAOB members are unconstitutional, the suit concludes.

“Despite its vast authority and the far-reaching consequences of its actions, the PCAOB is not accountable to our elected representatives,” CEI writes in the suit. “Its members are not appointed by the President or any of his top lieutenants, nor are they confirmed by the Congress. Its Board members cannot be removed by the President or any other single administrator accountable to him.”
If CEI is able to prove that the PCAOB appointments are unconstitutional, it would open the doors to challenges to the PCAOB’s disciplinary actions to date.

“In Freytag v. C.I.R. (1991) and later in Ryder v. United States (1995), the Supreme Court affirmed that an individual or firm disciplined by a government agency can challenge that discipline if agency officials were improperly appointed. Such challenges are permitted to give citizens an incentive to question improper appointments, and thus ensure that agencies remain accountable and respectful of constitutional protections,” CEI writes. “A challenger does not have to prove that, but for the improper composition of the Board, it would not have taken the action challenged. Its illegal appointment itself renders its actions invalid.”

Nick Morgan, a partner at DLA Piper who prosecuted securities fraud in the SEC’s Enforcement Division for more than seven years, said he doubts the Supreme Court would interpret the case in a way that would jeopardise Sarbanes-Oxley as a whole. Still, the fact that the Supreme Court will review the ruling at all bodes well for CEI.

“The Court of Appeals issued a clear ruling against the plaintiffs’ position, saying that the makeup of the Board was not unconstitutional and did not strip the President of the necessary powers to influence the Board,” he says. “But there was a very strong dissenting opinion on the panel that issued the ruling. It’s perhaps that dissenting opinion that got the Supreme Court’s attention, so the fact that the Court took the case makes me think that there’s a decent shot at the Competitive Enterprise Institute’s position prevailing. I’d hate to put odds on it, but the fact that the Court granted certiorari under these circumstances makes me think the Court will declare the PCAOB unconstitutional.”