June 28, 2010

Supreme Court Decides Free Enterprise Fund v. Public Company Accounting Oversight Board

On June 28, 2010, the Supreme Court decided Free Enterprise Fund v. Public Company Accounting Oversight Board, No. 08-861, holding that a statutory provision allowing the Securities and Exchange Commission ("SEC") to remove members of the Public Company Accounting Oversight Board ("PCAOB" or "the Board"), which the SEC appoints, only for "good cause" violates constitutional principles of separation of powers but that appointment of the Board's members by the SEC does not violate the Constitution's Appointments Clause.

The PCAOB, which was created by the Sarbanes-Oxley Act of 2002, exercises wide regulatory authority over accounting firms that audit public companies. The Board's members are appointed by the SEC, which is responsible for oversight of the Board, but the statute also provides that the SEC may remove Board members only for "good cause shown" and defines the concept of "good cause" quite narrowly. Members of the SEC, in turn, may be removed by the President only for "inefficiency, neglect of duty, or malfeasance in office."

The PCAOB inspected an accounting firm that is a member of the Free Enterprise Fund ("Fund"), issued a report critical of the firm's auditing procedures, and began a formal investigation. The firm and the Fund sued the Board, seeking a declaratory judgment that the limitations on removal of the Board's members unconstitutionally insulated them from presidential control. The fund also sought a declaration that the members' appointment by the SEC violated the Appointments Clause of the Constitution because they were appointed neither by the president nor by the "head" of a "department." The district court granted summary judgment for the Board, and the Court of Appeals for the District of Columbia Circuit affirmed, rejecting both challenges to the Board's validity.

The Supreme Court reversed. It first rejected the government's argument that challenges to the validity of the PCAOB's composition must first be brought to the Board itself, with review by appeal from a Board order imposing sanctions. Requiring a plaintiff to incur a sanction to test a law's validity, the Court said, would provide no "meaningful" avenue of relief. The Fund's constitutional claims lay outside the competence and expertise of either the PCAOB or the SEC, and they required no technical considerations of agency policy.

Turning to the merits, the Court held, first, that the double level of limitations on removal of PCAOB members contravenes separation of powers principles. According to those principles, the president is empowered to keep executive officers of the government accountable by the ability to remove them from office. Although previous cases (which the Court noted it was not reconsidering) have held that this removal power may be limited in the case of "independent agencies," no precedent exists for the statutory arrangement here, which provides two levels of restriction on the president's power. That arrangement unconstitutionally interferes with the president's ability to ensure that the laws are faithfully executed by the Board, and it makes the president less accountable for the misconduct of Board members. The Court therefore struck down the provision of the Sarbanes-Oxley Act requiring the SEC to find "good cause" for removing members of the PCAOB. They now may be removed by the SEC at will.

The Court rejected, however, the Fund's argument that appointment of PCAOB members by the SEC violated the Appointments Clause. The members are "inferior Officers" whose appointment the Constitution permits Congress to assign to "Heads of Departments." The Court held that the SEC is a department for this purpose and that the entire SEC—not just its chair—is the head of the department.

Based on these holdings, the Court concluded that a broad injunction against continued operation of the PCAOB was not appropriate. The Fund and its members 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." The Court left it to the lower courts to fashion such relief.

Chief Justice Roberts delivered the opinion of the Court, in which Justices Scalia, Kennedy, Thomas, and Alito joined. Justice Breyer filed a dissenting opinion in which Justices Stevens, Ginsburg, and Sotomayor joined. 

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