On June 28, 2010, the U.S. Supreme Court rejected a challenge to the existence of the Public Company Accounting Oversight Board (“PCAOB”) under the Sarbanes-Oxley Act of 2002 (“Act”) while holding that a part of the Act that limited the President’s ability to remove members of the PCAOB is unconstitutional. In 2002, the Act created the PCAOB to provide external and independent oversight of auditors of U.S. public companies in the wake of the Enron and other accounting scandals. The Court’s narrow
decision permits the PCAOB to continue its functions without interruption with the exception that PCAOB members may now be terminated at will by the Securities and Exchange Commission (“SEC”).
The Court’s decision in
Free Enterprise Fund v. Public Company Accounting Oversight Board, 561 U.S. ___ (2010), arose in an action filed in the United States District Court for the District of Columbia by an accounting firm registered with the PCAOB and a nonprofit organization. The PCAOB had inspected the accounting firm, publicly criticized its auditing procedures, and started a formal investigation. In response, the plaintiffs filed their action against the PCAOB seeking a declaratory judgment that the PCAOB is unconstitutional and an injunction barring the PCAOB from exercising its powers. The plaintiffs argued, among other things, that the Act “contravened the separation of powers by conferring wide-ranging executive power on [PCAOB] members without subjecting them to Presidential control.” The government intervened on the side of the PCAOB. The District Court granted summary judgment in favor of the government, upholding the constitutionality of the Act. A divided Court of Appeals affirmed.
The Supreme Court held that the Act contravened the separation of powers doctrine and was unconstitutional insofar as it limited the President’s authority to oversee inferior officers performing executive functions through removal. Chief Justice Roberts, writing for the majority in a 5 to 4 decision, reasoned that the Act imposed “a second level of tenure protection” that “not only protect[ed] [PCAOB] members from removal except for good cause, but withdr[ew] from the President any decision on whether that good cause exist[ed]” and that such a double layer of protection against removal was unconstitutional. In invalidating the statutory restrictions on removal of PCAOB members, the Court concluded that this left the PCAOB members subject to removal by the SEC at will.
The Act establishing the PCAOB did not have a severability clause. Thus, the declaration of any part of the Act as unconstitutional could have theoretically rendered the entire PCAOB unconstitutional. The Court refused to render such a broad holding and concluded that the unconstitutional provisions limiting the removal of PCAOB members are severable from the remainder of the statute. Therefore, the Court held that the plaintiffs were not entitled to an injunction against the PCAOB continuing to exercise its functions.
Four of the Supreme Court Justices dissented primarily out of concern that the Court’s ruling could have a disruptive impact on the functioning of other federal administrative agencies and on how Congress structures administrative agencies in the future. It remains to be seen whether
Free Enterprise Fund will have such an impact.
The PCAOB may continue its functions. The spotlight turns back to the financial reform legislation currently being debated in Congress, including potential legislation that may exempt smaller public companies (those with market values below $75 million) from complying with some of the internal control requirements of the Act.
Colton Carothers provided valuable assistance in the preparation of this article.