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.
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