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Supreme Court Rules on the PCAOB

On Monday, the Supreme Court, in a complex decision, found parts of the statute that created the Public Company Accounting Oversight Board ("PCAOB") to be unconstitutional.  However, the manner in which the Court addressed the issue left the day-to-day operations of the Board largely untouched, and the PCAOB will therefore continue to be a key regulator of accounting firms in the United States.

The PCAOB

The PCAOB was created in 2002 as part of the Sarbanes-Oxley Act, the reform legislation enacted in the wake of the Enron and Worldcom accounting scandals.  It regulates many accounting firms, has authority to inspect those firms, and violations of its rules can be treated as violations of the federal securities laws.  Importantly for this case, the PCAOB is run by a Chairman and four other members, each of whom is appointed by the SEC, and once appointed, can only be removed "for cause."  Similarly, the SEC Commissioners who hold this power are appointed by the President and confirmed by the Senate, but once appointed can also only be removed "for cause."

Summary of the Case

A small accounting firm in Nevada that was being investigated by the PCAOB filed suit, arguing that because the PCAOB's members were not subject to the control and supervision of the President, the PCAOB was formed unconstitutionally, and should be barred from exercising its powers.  The firm's argument was somewhat technical, but relied on a core principle of constitutional law: in our system of government, the separation of powers between the three branches of government requires that those who enforce the law (e.g., the leaders of the PCAOB) be subject to the supervision and control of the President.  In essence, the firm argued that the PCAOB was not consistent with constitutional principles because the SEC cannot remove PCAOB members "at will" and because SEC Commissioners are themselves subject to only limited supervision and control by the President.

The Court's Decision and Reasoning

The Supreme Court agreed with the firm's basic contention.  In brief, the Court held that it is not constitutionally permissible for the leadership of a law enforcement agency like the PCAOB to be insulated by two layers of "for cause" removal provisions.  However, the Court declined to follow the firm's suggestion that the PCAOB be barred from exercising its powers, and instead took the much more limited step of eliminating the "for cause" language from the statute.  Bottom line: PCAOB members can now be removed by the SEC at any time for virtually any reason, but the PCAOB will otherwise continue to conduct its business and exercise the powers it possesses.

The vote of the Court was 5-4, with Justice Breyer writing a dissenting opinion. While the dissenting opinion is, in many ways, equally complex, Justice Breyer's argument is essentially that the majority's overly formalistic approach to how the PCAOB is run unnecessarily inhibits the efficient and effective operations of the government.  As he wrote, the Court's opinion may ultimately "create an obstacle, indeed pose a serious threat, to the proper functioning of that workable government that the Constitution seeks to create."

What Does this Mean for the SEC and Other Agencies?

Importantly, the Court's decision does not appear to reopen debate on the constitutionality of the SEC itself (or that of numerous other independent agencies such as the Federal Trade Commission or the CFTC).  The Court took pains to emphasize that it was dealing only with situations of "multilevel protection," not situations like the SEC, where the Commissioners are directly appointed by the President, but once appointed, can only be removed from office under limited circumstances.  Further, the decision leaves the Sarbanes-Oxley legislation otherwise intact, remaining "fully operative as a law”.   SEC Chairman, Mary L. Schapiro, reacted to the decision with the following statement:

I am pleased that the Court has determined that the Board’s operations may continue and the Sarbanes-Oxley Act, with the Board’s tenure restrictions excised, remains fully in effect. The PCAOB is a cornerstone of the Sarbanes-Oxley Act and serves a critical role in promoting investor protection and audit quality.  We look forward to continuing to work with the Board in connection with its mission to oversee auditors in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports.

The SEC's statement about the decision is available at:  http://www.sec.gov/news/press/2010/2010-111.htm

For those legally inclined, the full text of the Court's slip opinion is available here.