Supreme Court Questions PCAOB’s Constitutionality

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The U.S. Supreme Court heard oral arguments in a lawsuit challenging the constitutionality of the Public Company Accounting Oversight Board, with several justices appearing to take the plaintiffs’ side in the case.

The case, Free Enterprise Fund v. Public Company Accounting Oversight Board, was brought on behalf of a small Nevada accounting firm, Beckstead & Watts, which challenged the constitutionality of the law after objecting to the PCAOB’s inspection findings. The Free Enterprise Fund, a conservative group opposed to government regulation, has lost the case twice before both a district judge and an appeals court. But if it wins the case before the Supreme Court, the ruling could have wide-ranging implications not only for the PCAOB and its oversight of public accounting firms, but also for the law that established the board: the Sarbanes-Oxley Act of 2002.

The plaintiffs argued that the PCAOB violates the separation of powers principles in the Constitution because the PCAOB’s members are appointed by the SEC and not directly by the president, and they cannot be fired except for cause. Several justices indicated some sympathy for that viewpoint in their questions.

“As a practical matter, does the president have any ability to control what the board does?” asked Associate Justice Samuel Alito.

Associate Justice Antonin Scalia, a proponent of the “unified executive” theory of government, also remarked on the limitation on the powers of the president with respect to the SEC and the PCAOB. “He cannot remove the commissioners, and it’s the commissioners that govern the board, not the chairman,” he said.

Alito noted that the members of the PCAOB earn more than the president or the SEC commissioners. “Suppose the president reads about that and he says, ‘This is outrageous. I want to change it,’” he said. “How can he do that? Remove the SEC commissioners unless they take action against the board?”

Chief Justice John Roberts wondered if the Sarbanes-Oxley law went too far in establishing the independence of the PCAOB “because you’ve got to rely on the SEC to get to the board.” He appeared to question how much authority the SEC actually has over the board.

“The board can act, and the SEC can, I suppose, retroactively veto their actions,” he said. “But the SEC doesn’t propose what actions the board takes, actions that can have significant, devastating consequences for the regulated bodies.”

However, Associate Justice Ruth Bader Ginsburg seemed sympathetic to the PCAOB’s case, noting, “The SEC is set up like the FCC, the other independent regulatory commissions, but this is a board that has a relationship with the SEC, where it can't do anything that doesn't have the SEC's approval."

Associate Justice Stephen Breyer indicated in his questions that the SEC had the enforcement authority, not the PCAOB. "So as far as, if the company was ever certain it was right and that the accounting board was out of control, completely wrong, the company would just say, 'I'm not complying; well, fine; do what you want,'" he said. "And then at that moment, the group that would decide whether they were right or the board was right would be the commission; is that right?"

Associate Justice Sonia Sotomayor also seemed skeptical of the Free Enterprise Fund attorney's arguments. "Let's break down each part of your argument, please," she said. "You are suggesting that Congress doesn't have the power to determine that a particular principal or agent of the government doesn't have certain responsibilities?"

The swing vote may be Associate Justice Anthony Kennedy. His former clerk, Brett Kavanaugh, is now a judge on the appeals court that heard the case last year and ruled in favor of the PCAOB. However, Kavanaugh sided with the Free Enterprise Fund in a dissenting opinion. Kennedy noted that the PCAOB members are independent of the SEC.

“The history and traditions of boards like this is that their investigative powers are independent,” he said. "Now, you say that there could be a rule, but that just isn't the way it works. And if you refer us to history and tradition for other purposes, we ought to look at the operational principles, operational assumptions of this board."

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