The future of the Public Company Accounting Oversight Board—and, by extension, the future of the Sarbanes-Oxley Act—may be in jeopardy, following a U.S. Supreme Court hearing last week where several justices criticized the accounting overseer as having too much independence.
The arguments on Dec. 7 capped an improbable three-year odyssey by a small Nevada accounting firm sanctioned by the PCAOB, which sued the Board in 2006 with the help of a conservative activist group. They contend that the PCAOB is unconstitutional because its board members are appointed by the Securities and Exchange Commission rather than the president, which gives the Board too much regulatory power unchecked by the executive branch.
The PCAOB was created under the Sarbanes-Oxley Act in 2002, in the wake of the Enron and WorldCom scandals. The Board oversees accounting firms that audit public companies in the United States, and has the power to sanction audit firms if they fail to adhere to PCAOB-endorsed auditing standards.
Carvin
The constitutional question before the court was how much control the president actually can exert over the PCAOB. Michael Carvin, a partner at the law firm Jones Day and lead plaintiff attorney, argued that PCAOB members have too much authority to investigate auditing firms and not enough oversight by the SEC.
Some of the more conservative justices seemed to agree. Chief Justice John Roberts, for example, noted that the PCAOB could impose “collateral consequences” on firms that don’t comply with its requests, all without input from the SEC.
The power of the president to remove PCAOB board members—or rather, his lack thereof—was another key sticking point. U.S. Solicitor General Elena Kagan stated: “The president has constitutionally sufficient control over the SEC. The SEC has comprehensive control over the accounting board. Therefore, the president has constitutionally sufficient control over the accounting board.”
“[T]he case is a tremendously important one, both for the constitutional issues it raises and for its implications for securities enforcement and financial regulation in general.”
— Donna Nagy,
Law Professor,
Indiana University School of Law
Justice Antonin Scalia, however, quickly responded: “Only because he can dismiss the chairman of the SEC. The knife that the president has into the SEC has no role in the control of this board.”
Kagan urged the court not to become fixated on the president’s removal authority. “Removal is not the ultimate constitutional question,” she said. “The ultimate constitutional question is the level of presidential control.” She argued that the president has the same control over the PCAOB as he has over the SEC, in the sense that the Commission acts as a conduit for the president to exert control over the PCAOB.
Roberts didn’t agree. He noted that if the SEC decides it has no cause to remove a board member, then the president would have to remove all SEC commissioners—not just the chairman—and he, too, can only do that for cause. “That’s for-cause squared, and that’s a significant limitation on the president’s power that this court has not recognized before,” he said.
Justice Ruth Bader Ginsburg, on the other hand, disputed Carvin’s characterization of the PCAOB as an unaccountable, independent agency. “It can’t even issue a subpoena without the SEC’s approval,” she said.
Looking Ahead
As often happens with the Supreme Court these days, the swing vote may well come down to Justice Anthony Kennedy. He was circumspect in his comments during the hearing, but PCAOB advocates have one worrying omen already: Judge Brett Kavanaugh of the U.S. Court of Appeals for the District of Columbia wrote a dissenting opinion last year saying the PCAOB is indeed unconstitutional—and Kavanaugh is a former Kennedy law clerk.
Nagy
A ruling is not likely to come until spring, when the court renders most of its decisions. No matter which way it finds, the implications could be significant, experts say.
ELENA KAGAN ARGUMENT
Below is an excerpt of U.S. Solicitor General Elena Kagan arguing on behalf of the PCAOB and the U.S. government.
SOLICITOR GENERAL KAGAN: Mr. Chief Justice, and may
it please the Court:
Resolution of this case follows from a
simple syllogism and it is this: The President has
constitutionally sufficient control over the SEC. The
SEC has comprehensive control over the Accounting Board,
therefore the President has constitutionally sufficient
control over the Accounting Board. Now, Mr. Carvin has suggested that there …
JUSTICE SCALIA: Excuse me. The President
has adequate control over the SEC only because he can
dismiss the chairman of the SEC. But the activity here
is not governed by the chairman of the SEC. There is no
role whatever for the chairmanship. The -- the
governance of this board is by the members of the SEC.
So that’s quite different from saying -- you know, I --
I think your syllogism breaks down at that point.
KAGAN: Well, I -- I -- I think not,
Justice Scalia. Humphrey’s Executor said 70 years ago
the President does have constitutionally sufficient
control over the SEC generally, including the chair.
Now, the SEC has constitutionally -- has
comprehensive control over the accounting board. There
is nothing that the accounting –
JUSTICE SCALIA: The chairman, which is --
which is -- which is the, what should I say, the knife
that the President has into the SEC, has no role in the
control of this board.
KAGAN: The -- the chair has the
same role that he has with respect to pretty much
everything else that the SEC does. The SEC –
CHIEF JUSTICE ROBERTS: No. I thought the
employees were appointed by the chairman, not by the
commission.
KAGAN: Subject to the control --
subject to the approval of the commission.
CHIEF JUSTICE ROBERTS: So you think -- you
think a -- a veto power is the same as an original --
original power?
KAGAN: Well, in fact, the
commission could do the exact same thing in this case.
The commission could delegate its control over the
Accounting Board to the chair, subject to the control of
the commission again.
So I think that there is no difference with
respect to the SEC’s supervision of the board than there
is with respect to the SEC’s supervision of any of its
other functions or any –
CHIEF JUSTICE ROBERTS: Let’s say –
KAGAN: -- of its staff.
Source
Oral Argument in PCAOB Case (Dec. 7, 2009).
“[T]he case is a tremendously important one, both for the constitutional issues it raises and for its implications for securities enforcement and financial regulation in general,” says Donna Nagy, law professor at Indiana University School of Law.
Kazman
Foremost, if the court overturns the PCAOB that could endanger the entire Sarbanes-Oxley Act. The law lacks a severability clause, meaning that if any portion of it is struck down, the rest of the statute comes down with it. Congress would then need to amend SOX if it wanted the statute to survive. Given that Congress is already tinkering with ways to relax SOX compliance challenges, “it’s very possible that Congress will be even more receptive to reexamining this issue, if the Court were to rule that something was invalid in the way the PCAOB was set up,” says Sam Kazman, an attorney for the Competitive Enterprise Institute, which has lined up against the PCAOB.
King
If the court upholds the PCAOB as constitutional, however, that could serve as a template for many other independent executive agencies, experts say. Congress might then feel free to create more agencies with the “double for-cause removal architecture,” an extra step away from executive oversight, says Ronald King, an accounting professor and dean of the business school at Washington University.
Nagy described such a regulatory world as “troubling,” because it will lead to “independent regulators answerable only to other independent regulators … less accountable to the public,” she said.
But many find the alternative of ending the PCAOB equally unsettling. “The PCAOB is the lynchpin of SOX,” says William Currier, a partner in the law firm White & Case. “It basically empowers auditors to do their jobs.”
Currier
Currier says the whole premise of the PCAOB was to strengthen the procedures that make corporate financial statements credible. Now that auditors have an overseer to answer to, that has given them the impetus to identify many financial reporting concerns that never came to the surface before, such as troublesome payments that might lead to investigations under the Foreign Corrupt Practices Act.
“That’s what it’s all aimed at,” Currier says. “So you take this out of the picture, and I think it weakens the entire architecture.”
Nagy says Congress could always split the difference. “If the PCAOB’s double-decker independence is declared unconstitutional, Congress will likely act quickly to restructure the PCAOB either as a unit within the SEC with members who are SEC employees, or as a traditional independent regulatory agency,” she says. “If Congress recreates the PCAOB as a new federal agency, that PCAOB could be an even stronger and more effective accounting regulator than the PCAOB it replaced.”
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