Supreme Court Invalidates For-Cause
Removal of Public Company Accounting
Oversight Board Members
On June 28, 2010, the Supreme Court issued its opinion in Free Enterprise Fund, et al. v. Public Company Accounting Oversight Board, et al., 561 U.S. ___, No. 08-861. The case involved a constitutional challenge to the establishment of the Public Company Accounting Oversight Board (“PCAOB” or the “Board”) in the Sarbanes-Oxley Act of 2002 (“Act”). In a 5-4 decision, the Court struck down the provisions of the Act that restrict the authority of the Securities and Exchange Commission (“SEC” or “the Commission”) to remove PCAOB members, holding that those removal provisions violate constitutional separation of powers principles. The Court left standing the remainder of the Act, holding that the PCAOB and its exercise of regulatory authority pose no constitutional problems so long as PCAOB members may be removed by the SEC at will. The Court thus allowed the PCAOB to continue its work prospectively without interruption, without addressing the validity of the Board’s past actions.
The Statutory Framework
The Sarbanes-Oxley Act of 2002 (the “Act”) was passed by Congress and signed into law in the wake of front-page accounting scandals such as Enron and WorldCom. Title I of the Act established the PCAOB and charged it with the mission “to oversee the audit of public companies that are subject to the securities laws … in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.” 15 U.S.C. § 7211(a).
The Act provided that the SEC “shall have oversight and enforcement authority over the Board.” Id. § 7217(a). The PCAOB’s five members are appointed by the SEC “after consultation with the Chairman of the Board of Governors of the Federal Reserve System and the Secretary of the Treasury.” Id. § 7211(e)(4). The Act also author ized the SEC to remove a Board member “for good cause” if the SEC determines after notice and a hearing that the member “has willfully violated any provision of this Act, the rules of the Board, or the securities laws;” “has willfully abused the authority of that member;” or “without reasonable justification or excuse,
ACCOUNTANTS LIABILITY UPDATE
Accountants Liability Practice With highly skilled and experienced lawyers in Chicago, Los Angeles, New York, San Francisco and Washington, D.C., we are able to provide efficient and comprehensive assistance in matters arising all over the country. Each of the more than two dozen partners in our Accountants/ Professional Service Firms Liability practice has many years of experience regularly representing accounting firms and individual accountants, and our lawyers have represented accountants and accounting firms in matters in at least 38 states. In addition, we have extensive international experience, representing foreign firms in matters pending within the United States and assisting those clients in matters pending outside the United States.
Supreme Court Practice
One of the first law firms to have a dedicated national Appellate group, Sidley has one of the preeminent Supreme Court practices in the country and our lawyers represent clients on vir tually ever y type of federal legal issue, including bankruptcy, criminal, constitutional, antitrust, transportation, IP, communications, employment, civil r ights, tax, gover nment contracts, arbitration and health law. Since the Appellate practice began in 1985, Sidley lawyers have briefed well over 160 cases on the merits before the Court and have argued more than 85 cases.
Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, 212.839.5300 and One South Dearborn, Chicago, IL 60603, 312.853.7000. Prior results do not guarantee a similar outcome.
ThisSidley Updatehas been prepared by Sidley Austin LLP for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers.
To receive future copies of this and other Sidley Updates via email,
please sign up at www.sidley.com/subscribe
has failed to enforce compliance with any such provision or rule, or any professional standard by any registered public accounting firm or any associated person thereof.” Id. §§ 7211(e)(6), 7217(e)(3). With limited exceptions, the Act subjected r ules of the Board to pr ior approval by the Commission, Id. § 7217(b)(2), and gave the Commission author ity to amend those r ules, Id. § 7217(b)(5). The Commission was required to review and approve disciplinary actions taken by the Board. Id. § 7217(c). The Act also provided the authority for the SEC to limit or remove Board authority altogether. Id. §§ 7217(d)(1), (2). Finally, the Act fully preserved the SEC’s authority to regulate the accounting profession, to set standards, and to take any action against any registered public accounting firm or associated person. Id. § 7202(c).
The Litigation
Petitioners in Free Enterprise Fund included Beckstead and Watts, LLP (“Beckstead”), a public accounting firm registered with the PCAOB. After an inspection uncovered apparent deficiencies in several Beckstead audits, the PCAOB initiated a for mal investigation. Beckstead, together with the Free Enterprise Fund, responded by filing suit against the PCAOB, asserting that the statutory scheme creating the Board and providing for the appointment and removal of Board members, on its face, violates the Constitution’s Appointments Clause and the constitutional principle of separation of powers. Under the Appointments Clause, the President alone has authority to appoint “Officers of the United States,” although “inferior Officers” may also be appointed by “Heads of Departments.” And separation of powers principles—implicit in the first three articles of the Constitution that define separate roles for the legislative, executive, and judicial branches—have been interpreted to prohibit Congress from unduly restricting the President’s ability to supervise and remove executive officers. The district court rejected both challenges to the Act and granted summary judgment to the PCAOB. In August 2008, a divided D.C. Circuit affirmed dismissal of petitioners’ facial constitutional challenge to the Act, holding that the provisions
for appointment and removal of Board member s were constitutional in light of the SEC’s authority over the Board, w h i c h t h e D. C. C i rc u i t d e s c r i b e d a s “ e x p l i c i t a n d comprehensive” and “extraordinary.” Free Enterprise Fund, et al. v. Public Company Accounting Oversight Board, et al., 537 F.3d 667, 669 (D.C. Cir. 2008), aff’d in part, rev’d in part 561 U.S. ___, No. 08–861 (June 28, 2010). In a lengthy dissent, Judge Kavanaugh rejected the majority’s conclusions with respect to both the separation of powers and Appointments Clause challenges. 537 F.3d at 685-715 (Kavanaugh, J., dissenting).
Decision of the Supreme Court
The Supreme Court reversed in part, holding in a 5-4 decision that the statutor y provision that PCAOB members are removable by the SEC only for cause was an unconstitutional violation of separation of powers principles. Chief Justice Roberts wrote for the majority, while Justice Breyer wrote a lengthy dissent that was joined by Justices Stevens, Ginsburg and Sotomayor.
Preliminarily, although the statute established the Board as a pr ivate “nonprofit cor poration” whose member s and employees are not considered Government “officer[s] or employee[s],” see 15 U.S.C. §§ 8211(a)-(b), the Court accepted the parties’ view that the Board is in fact “a Government-created, Government-appointed entity, with expansive powers to govern an entire industry.” Slip op. at 3. In light of the Board’s extensive regulatory authority—including its authority to “promulgate[ ] auditing and ethics standards, perform[ ] ro u t i n e i n s p e c t i o n s o f a l l a c c o u n t i n g f i r m s , d e m a n d [ ] d o c u m e n t s a n d t e s t i m o ny, a n d i n i t i a t e [ ] f o r m a l investigations and disciplinary proceedings”—the Court accepted that, as the parties had agreed,“the Board is ‘part of the Government’ for constitutional purposes.” Slip op. at 4. The Court next addressed whether the district court had jurisdiction to hear the constitutional challenge in light of the United States’ assertion that the plaintiffs had failed to seek SEC review of the Board’s action, and then challenge any resulting o rd e r o f t h e S E C i n f e d e r a l c o u r t . S e e 1 5 U. S. C. § §
7217(b)(2)-(4), (c)(2); 15 U.S.C. §§ 78y(a)(1), (b)(1), (c)(1). The Supreme Court rejected this argument. It held that § 78y does not provide “an exclusive route to review” of PCAOB action, and that nothing in the statutory scheme indicated that Congress intended to limit the courts’ jurisdiction. Slip op. at 8. The Court went on to explain that the plaintiffs could not “meaningfully pursue their constitutional claims” by invoking § 78y to seek judicial review of an SEC action, for not all P CAO B a c t i o n s o r r u l e s a re “ e n c a p s u l a t e d i n a f i n a l Commission order or rule,” and, in any event, the plaintiffs’ c o n s t i t u t i o n a l c l a i m s a re “ o u t s i d e t h e C o m m i s s i o n ’s competence and expertise.” Id. Finally, the Court declined to require petitioners to incur Board sanctions—reviewable by the SEC and then in federal court—in order to obtain judicial review. Id.
Having concluded that it had jurisdiction, the Court next went on to examine whether the statute’s requirement that PCAOB members be removed only for cause was consistent with constitutional separation of powers principles. The Court noted that “the parties agree that the [SEC] Commissioners cannot themselves be removed by the President” without cause, slip op. at 5, and further noted that in the Court’s prior cases, it had approved statutes restricting the President’s ability to remove an executive officer to for-cause removal, slip op. at 14. The statute creating the PCAOB, however, provided two layers of for-cause removal: the SEC could remove PCAOB members only for cause, and the President could in turn remove SEC commissioners only for cause. Id. This “added layer of tenure protection” had the effect of “not only protect[ing] Board members from removal except for good cause,” but also “withdraw[ing] from the President any decision on whether that good cause exists.” Id. In other words, the President had neither the power to determine whether Board members were subject to for-cause removal, nor direct oversight of the SEC commissioners who did have the power to determine whether Board members were subject to for-cause removal. Even if the President were to disagree with the conclusion of the SEC Commissioners that removal of a
PCAOB member was appropr iate, “he is powerless to intervene—unless that determination is so unreasonable as to constitute ‘inefficiency, neglect of duty, or malfeasance in office.’” Slip op. at 15.
The Court concluded that these limitations on the President’s ability to control PCAOB members were too great. Because the President “is not the one who decides whether Board members are abusing their offices or neglecting their duties,” he “can neither ensure that the laws are faithfully executed, nor be held responsible for a member’s breach of faith.” Id. The voting public thus could not hold the President accountable for the actions of the Board. Id. at 17-18.
The Court went on to find that the breadth of the SEC’s control over the PCAOB could not overcome the separation of powers problems created by the SEC’s inability to remove PCAOB members at will. As the Court explained,“[b]road power over Board functions is not equivalent to the power to remove Board members . . .The Commission cannot wield a free hand to supervise individual members if it must destroy the Board to fix it.” Slip op. at 23. Moreover, despite the SEC’s authority to closely review Board actions, the PCAOB “has significant independence in determining its priorities and intervening in the affairs of regulated firms (and the lives of their associated persons) without Commission preapproval or direction.” Id. at 24.
In sum, the Court found that the limitations on the SEC’s authority to remove PCAOB members could not stand. The Court rejected the plaintiffs’ call, however, for a broad ruling that the PCAOB and “all power and authority exercised by it” were unconstitutional. Slip op. at 27-28. Instead, the Court held that the tenure provisions—implemented in 15 U.S.C. §§ 7211(e)(6) and 7217(d)(3)—could simply be severed from the Sarbanes-Oxley Act, leaving the remainder of the Act fully operational. Id. at 28. Although the Act does not contain an express severability clause, the Court found “nothing in the statute’s text or historical context [that] makes it ‘evident’ that C o n g re s s , f a c e d w i t h t h e l i m i t a t i o n s i m p o s e d by t h e
Constitution, would have preferred no Board at all to a Board whose members are removable at will.” Id. at 29.
Finally, the Court rejected plaintiffs’ claims that the Act was also invalid under the Appointments Clause because it called for PCAOB members to be appointed by the SEC, rather than the President. In light of the SEC’s authority to review PCAOB action, and given that PCAOB members are, under the Court’s ruling, removable at will by the SEC, the Court had “no hesitation in concluding that… the Board members are inferior officers whose appointment Congress may permissibly vest in a ‘Hea[d] of Departmen[t],” including the SEC. Slip op. at 30-32. The existing Board members have thus “been validly appointed by the full Commission.” Id. at 33.
Because the provisions of the Sarbanes-Oxley Act creating the PCAOB and vesting its members with authority are—with the sole exception of the removal provisions—fully constitutional, the Court found that the plaintiffs “are not entitled to broad injunctive relief against the Board’s continued operations.” Slip op. at 33. Instead, plaintiffs are entitled only to “declaratory relief sufficient to ensure that the reporting requirements and auditing standards to which they are subject will be enforced only by a constitutional agency accountable to the executive.” Id. In dissent, Justice Breyer broadly disagreed with the majority’s separation of powers analysis. Counseling a functional approach to the separation of powers inquiry, Justice Breyer stated that eliminating the for-cause limitation on the SEC’s power to remove PCAOB members would have no meaningful effect on the President’s control of the Board. “[S]o long as the President is legitimately foreclosed from removing the
Commissioners except for cause (as the majority assumes),
nullifying the Commission’s power to remove Board members only for cause will not resolve the problem the Court has identified: The President will still be ‘powerless to intervene’ by removing the Board members if the Commission reasonably decides not to do so.” Slip op. at 12 (Breyer, J., dissenting). At the same time, in Justice Breyer’s view, compelling reasons exist to permit the removal restriction to stand. PCAOB members
sometimes serve in an adjudicative capacity, which has been recognized as a reason to restrict removability, and PCAOB members are also “technical professional experts” whose conduct should not be subject to political influence. Id. at 17-19. In addition, Justice Breyer expressed the concern that the principle behind the majority’s position was inadequately defined and could have a potentially far-reaching impact on numerous other aspects of the federal government. Id. at 20-33. Finally, signaling an issue that could potentially arise in future cases, Justice Breyer questioned the majority’s willingness to “assume without deciding that the SEC Commissioners themselves are removable only ‘for cause.’” Slip op. at 33. Although the SEC is an “independent” agency, there is no express statutory limitation on the President’s authority to remove SEC Commissioners; indeed, the statute establishing the SEC “is silent on the question” of removability. Id. at 34-35. Moreover, the statute creating the SEC was enacted at a time when, according to then-existing Supreme Court law, for-cause limitations on removability were considered to be unconstitutional. Id. Given that the for-cause removability of SEC Commissioners was essential to the majority’s separation of powers analysis, Justice Breyer criticized the majority’s decision to strike down the PCAOB removal provisions based on a “phrase that does not appear in the relevant statute and which Congress probably did not intend to write.” Id. at 36.
Practical Implications for the PCAOB
Although this case was described in the D.C. Circuit as “the most important separation-of-powers case regarding the President’s appointment and removal powers to reach the courts in the last 20 years,” Free Enterprise Fund v. PCAOB, 537 F.3d at 685 (Kavanaugh, J., dissenting), the practical effect of the Supreme Court’s decision appears to be limited: the PCAOB may function prospectively without interruption and may continue to exercise the same regulatory authority that it has in the past. The Court’s decision simply excised the two narrow paragraphs of the Act—§§ 7211(e)(6) and 7217(d)(3)—that had constrained the SEC’s removal power, while leaving the rest of
If you have questions about any of these items, please contact your regular Sidley Austin LLP contact or one of the following:
Jeffrey C. Sharer David S. Petron Tacy F. Flint
+1.312.853.7028 +1.202.736.8093 +1.312.853.7875
[email protected] [email protected] [email protected]
BEIJING BRUSSELS CHICAGO DALLAS FRANKFURT GENEVA HONG KONG LONDON LOS ANGELES NEW YORK PALO ALTO SAN FRANCISCO SHANGHAI SINGAPORE SYDNEY TOKYO WASHINGTON, D.C. www.sidley.com
Sidley Austin LLP, a Delaware limited liability partnership which operates at the firm’s offices other than Chicago, London, Hong Kong, Singapore and Sydney, is affiliated with other partnerships, including Sidley Austin LLP, an Illinois limited liability partnership (Chicago); Sidley Austin LLP, a separate Delaware limited liability partnership (London); Sidley Austin LLP, a separate Delaware limited liability partnership (Singapore); Sidley Austin, a New York general partnership (Hong Kong); Sidley Austin, a Delaware general partnership of registered foreign lawyers restricted to practicing foreign law (Sydney); and Sidley Austin Nishikawa Foreign Law Joint Enterprise (Tokyo). The affiliated partnerships are referred to herein collectively as Sidley Austin, Sidley, or the firm.
the statute “fully operative as a law.” Slip op. at 28 (quoting Alaska Airlines, Inc. v. Brock, 480 U.S. 678, 684 (1987)). Thus, the only change in the Board’s status is that its members may now be removed at will by the SEC.
The Court did not explicitly address whether past actions of the PCAOB were subject to reconsideration in light of the decision here—likely because plaintiffs had not challenged any specific past action. In other cases, the Court has allowed that past actions of an agency may have “de facto validity” even where the Court later finds a constitutional defect in the agency’s establishing statute.
Buckley v. Valeo, 424 U.S. 1, 142 (1976). However, whether and to what extent that principle will be applied to the PCAOB’s past
