Interesting Appointments Clause Issue:
A Competitive Enterprise Institute paper (cowritten by Hans Bader and John Berlau) argues that part of Sarbanes-Oxley violates the Appointments Clause ("[The President] shall nominate, and by and with the Advice and Consent of the Senate, shall appoint . . . [all] Officers of the United States . . .: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments."):
The Sarbanes-Oxley Act of 2002 created a powerful quasi-private agency to oversee the auditing of American business, the Public Company Accounting Oversight Board (PCAOB). . . . Congress gave the power to appoint the members of the PCAOB not to the President, but to the five members of the Securities and Exchange Commission. This method of appointment violates the Appointments Clause in numerous ways. The Appointments Clause gives only the President the power to appoint the nation's principal officers, and allows low-ranking officers to be picked only by the President, a court, or by a single head of a cabinet-level department. The five commissioners of the SEC, as a group, don't fall under any of these categories.
Above all, the authors conclude, the Appointments Clause violation creates a lack of accountability for rules that hurt businesses and don't help investors. They note that England's abuses with offices spawning more offices led the Constitution's Framers to take great care to ensure that the power to appoint was limited to the very top officials of the Executive Branch. . . .
I know a bit about the Appointments Clause, but I'm no expert on the subject; and I know nothing about Sarbanes-Oxley. My sense is that the main questions would be (1) whether the PCAOB members are "inferior officers," and (2) whether the SEC board qualifies as a "head of department." (The notion of plural agency heads is familiar in modern legalese, though it might have been outside the contemplation of the Framers, who I suspect neither anticipated independent administrative agencies nor even non-independent departments who would be run by a board rather than by an individual.) The test for question 1, I believe, is whether the appointee "exercis[es] significant authority pursuant to the laws of the United States," and to answer that one would need to know both the precise powers of the Board, and the caselaw defining what's "significant."
Nonetheless, despite my massive gaps in knowledge here, my colorability antennae (or would it be colorability cones?) are giving me positive signals here -- whether or not it's a winning argument, it seems at least a plausible and interesting one. I'd love to hear what people think about, but please comment only if you're knowledgeable about the Appointments Clause caselaw, about the nature of the PCAOB, or about both. For the purposes of this discussion, I'm much interested not in what the structure of our government or of our accounting industry should be (so no arguments, please, that the SEC is just plain unconstitutional from the get-go), but rather in whether the PCAOB appointments method is indeed unconstitutional under current law.
More on The Interesting Appointments Clause Issue:
Lawprof Donna Nagy writes:
I've been out of town for a few days, so I just saw your post on the PCAOB and the Appointments Clause. I discussed the appointments clause issue extensively in my article, Playing Peekaboo with Constitutional Law: The PCAOB and its Public/Private Status, 80 Notre Dame Law Review 973 (2005) (pages 1049-53). As I point out in the article, the PCAOB also triggers separation of powers questions that are related to the appointments clause issue: whether Congress can shield the PCAOB's enforcement function from presidential control by placing the responsibility for oversight -- including the power to remove the PCAOB's five members -- in a source other than the President. (see pages 1053-57).
A threshold issue to any constitutional challenge under the appointments clause or the doctrine of separation of powers is whether the PCAOB is an entity of the federal government notwithstanding Congress's pronouncement in the Sarbanes-Oxley Act that the PCAOB is a private nonprofit corporation. Based on the analysis in Lebron v. National Railroad Passenger Corp., I conclude that the PCAOB must be considered the "government itself" for purposes of constitutional law (pp. 1036-44)
Here's a link to an earlier draft of the article on SSRN.
I see that the Free Enterprise Fund filed a complaint yesterday challenging the constitutionality of the PCAOB.
Given the stakes, litigation over the PCAOB's constitutional status was inevitable.
Free Enterprise Fund v. PCAOB -- Humphrey's Executor Squared:
This morning the U.S. Court of Appeals for the D.C. Circuit released its long-awaited opinion in Free Enterprise Fund v. Public Company Accounting Oversight Board, a challenge to the constitutionality of the PCAOB on appointments clause grounds. Judge Rogers, joined by Judge Brown, rejected the Free Enterprise Fund's challenge.
In this facial challenge, appellants contend that Title I of the Sarbanes-Oxley Act of 2002 (“the Act”) . . . violates the Appointments Clause of the Constitution and separation of powers because it does not permit adequate Presidential control of the Public Company Accounting Oversight Board (“the Board”). Congress, however, made the Board’s exercise of its duties subject to the comprehensive control of the Securities and Exchange Commission (“the Commission”). Under the Act, the Commission is empowered to set Board rules and procedures, to overturn any sanction proposed by the Board, and to limit or relieve the Board of its powers; the Commission also may remove members of the Board for cause. Members of the Commission, in turn, are appointed by the President with the advice and consent of the Senate and subject to removal by the President for cause; its chairman is selected by and serves at the pleasure of the President. In appellants’ view this statutory scheme vests Board members “with far reaching executive power while completely stripping the President of the authority to appoint or remove those members or otherwise supervise or control their exercise of that power.” . . . But their facial challenge ignores the entirety of the statutory scheme and runs afoul of the Supreme Court’s instruction regarding the nature of the President’s constitutional relationship with independent administrative agencies. Supreme Court precedent as we have it does not support appellants’ singular focus on removal powers as the be-all and end-all of Executive authority, but rather compels a more nuanced approach that examines the myriad means of Executive control.
We hold, first, that the Act does not encroach upon the Appointment power because, in view of the Commission’s comprehensive control of the Board, Board members are subject to direction and supervision of the Commission and thus are inferior officers not required to be appointed by the President. Second, we hold that the for-cause limitations on the
Commission’s power to remove Board members and the President’s power to remove Commissioners do not strip the President of sufficient power to influence the Board and thus do not contravene separation of powers, as that principle embraces independent agencies like the Commission and their exercise of broad authority over their subordinates. Accordingly, we affirm the grant of summary judgment to the Board and the United States.
Judge Kavanaugh penned a 58-page must-read dissent (which, admittedly, I've only skimmed).
This case raises fundamental questions about the scope of the President’s constitutional power to appoint and remove officers in the
Executive Branch. Article II begins: “The executive Power shall be vested in a President of the United States of America.” Under Article II, the President possesses the sole power and responsibility to “take Care that the Laws be faithfully executed.” To assist in his duties, the President has authority, within certain textual limits, to appoint and remove executive officers. Myers v. United States. . . . Disputes over the scope of the President’s appointment and removal powers have arisen sporadically throughout American history. This latest chapter involving the Public Company Accounting Oversight Board is the most important separation-of-powers case regarding the President’s appointment and removal powers to reach the courts in the last 20 years.
The Public Company Accounting Oversight Board is an independent executive agency created by the Sarbanes-Oxley Act of 2002. The PCAOB is considered an “independent” agency because the five members of the PCAOB are removable only for cause, not at will. The PCAOB portrays itself as just another independent executive agency – like the FCC, the FTC, and the NLRB – that is permissible under the Supreme Court’s 1935 decision in Humphrey’s Executor. Plaintiffs, including a Nevada accounting firm regulated by
the Board, strenuously disagree and challenge its constitutionality. Plaintiffs object to the fact that members of the PCAOB are appointed by and removable for cause by another independent agency, the Securities and Exchange Commission, rather than by the President. They argue that this structure, an independent agency appointed by and removable only for cause by another independent agency: (i) interferes with the President’s Article II authority to remove executive officers, and thereby exercise the executive power and take care that the laws be faithfully executed; and (ii) violates the specific terms of the Appointments Clause of Article II regarding the President’s authority to appoint
“principal officers” in the Executive Branch. Plaintiffs contend that “vesting government agencies with coercive power over the citizenry, and simultaneously depriving the citizenry of any ability to control or check those exercising such potentially tyrannical authority, is precisely the fundamental threat to the ‘liberty and security of the
governed’ that separation of powers principles were designed to prevent.” . . .
On the removal issue, the majority opinion views this case as Humphrey’s Executor redux. But this case is Humphrey’s Executor squared. There is a world of difference between the legion of Humphrey’s Executor-style agencies and the PCAOB: The heads of the Humphrey’s Executor independent agencies are removable for cause by the President, whereas members of the PCAOB are removable for cause only by another independent agency, the Securities and Exchange Commission. The President’s power to remove is critical to the President’s power to control the Executive Branch and perform his Article II responsibilities. Yet under this statute, the President is two levels of for-cause removal away from Board members, a previously unheard-of restriction on and attenuation of the President’s authority over executive officers. This structure effectively eliminates any Presidential power to control the PCAOB, notwithstanding
that the Board performs numerous regulatory and lawenforcement functions at the core of the executive power. So far as the parties, including the United States as intervenor,
have been able to determine in the research reflected in their exhaustive and excellent briefs, never before in American history has there been an independent agency whose heads are appointed by and removable only for cause by another independent agency, rather than by the President or his alter ego. But that is the case with PCAOB members, who are
removable for cause only by the SEC – and it is undisputed that the SEC as an independent agency is not the President’s alter ego. The PCAOB thus goes well beyond what historical
practice and Humphrey’s Executor authorize.
This is a huge case (I used the fact pattern for my Admin Law exam a few years back), and one I expect will either go en banc or produce some en banc dissents.
Rehearing Sought in PCAOB Case:
The Free Enterprise Fund has filed a petition for rehearing en banc in Free Enterprise Fund v. Public Company Accounting Oversight Board, in which a divided panel of the U.S. Court of Appeals for the D.C. Circuit rejected the Fund's Appointments Clause challenge to the PCAOB's composition. In my view, this case is an excellent candidate for en banc rehearing. Judge Kavanaugh wrote a powerful (and, in my view, persuasive) dissent, and the case raises an issue of exceptional importance.
Will Free Enterprise Fund v. PCAOB Go Up?
Last Monday, the U.S. Court of Appeals for the D.C. Circuit denied the Free Enterprise Fund's petition for rehearing en banc in Free Enterprise Fund v. PCAOB, a challenge to the constitutionality of the Public Company Accounting Oversight Board created by the Sarbanes-Oxley Act, by a vote of 5-4. Chief Judge Sentelle and Judges Griffith, Kavanaugh, and Ginsburg voted for rehearing. Judges Henderson, Rogers, Tatel,
Garland, and Brown voted against. A copy of the order is here. The Fund's attorneys at Jones Day and the Competitive Enterprise Institute promise a petition for certiorari is forthcoming.
Breaking: Sarbanes-Oxley to the Supremes:
This morning the Supreme Court granted certiorari in Free Enterprise Fund v. Public Company Accounting Oversight Board, a constitutional challenge to portions of the Sarbanes-Oxley Act. Appointments Clause cases don't come along all that often, and this one's a doozy — "Humphrey's Executor squared" according to Judge Kavanaugh's dissent on the D.C. Circuit. Our prior posts on this case are collected here.
Links to the filings, and today's other cert grants, are on SCOTUSBlog here.
Early Commentary on Free Enterprise Fund v. PCAOB:
NYU law professor Rick Pildes has a lengthy post on Balkinization previewing Free Enterprise Fund v. PCAOB, "the most important challenge in two decades in the ongoing debate between those who believe in the “unitary executive branch” theory of Art. II of the Constitution and those who endorse the constitutional validity of independent agencies." Prof. Pildes, who represented amici supporting the PCAOB below, doubts the Supreme Court will invalidate the Board unless it is willing to challenge the constitutionality of independent agencies. I am not so sure.
As I read it, Prof. Pildes' argument rests on the claim that the Board is under the SEC's near-complete control, and thus the Board's members are inferior officers. This may be true insofar as the SEC's authority over the Board is concerned, but the statute also provides that Board members can only be removed for cause. This structural feature necessarily attenuates the SEC's practical control over the Board — even if SEC retains near-plenary authority to direct or overturn Board actions — and dramatically diminishes any Presidential control over the Board. Structure matters, and agency costs are real. Accepting that independent agencies are constitutional (either on first principles or precedent), does not mean that anything goes. It may be kosher to create an agency at one level of remove from direct Presidential authority, and still impermissible to nest one independent agency within another. Or, to paraphrase Judge Kavanaugh's dissent below, accepting Humphrey's Executor does not require accepting Humphrey's Executor squared. I would agree with Prof. Pildes, however, that it may be difficult for the Cort to invalidate the PCAOB without casting doubt on other Appointments Clause precedents, such as Morrison v. Olson.
Former Solicitor General Kenneth Starr and former Assistant AG Viet Dinh have a different take on the case, as they represent the plaintiffs. Last Friday they had an op-ed in the WSJ arguing not only that the PCAOB is unconstitutional, but also that the Board's "lack of an accountable structure has likely contributed to what members of both parties see as its policy failures."
This is a fascinating and potentially important case (as I stressed to my Administrative Law students last year), and it is definitely worth watching.
UPDATE: Professor Bainbridge has more here.
The new Sarbanes-Oxley case:
Since the Supreme Court has granted cert in Free Enterprise Fund v. PCAOB (see here), I thought I would share a summary of the facts of the case, which I prepared as a study guide for my Administrative Law class at University of Houston:
In 2002, following a series of accounting scandals that exposed weaknesses in the reporting requirements for publicly held companies, Congress passed the Sarbanes-Oxley Act of 2002 ("the Act" or "SOX"). Title I of the Act established the Public Company Accounting Oversight Board ("the Board" or "PCAOB") as a new entity to oversee the audits of public companies. The Board's purpose is "to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports for companies the securities of which are sold to, and held by and for, public investors." In particular, the Act provides that:
The Board shall, by rule, establish, including, to the extent it determines appropriate, through adoption of standards proposed by 1 or more professional groups of accountants [which it shall designate] or advisory groups [which it shall convene], and amend or otherwise modify or alter, such auditing and related attestation standards, such quality control standards, and such ethics standards to be used by registered public accounting firms in the preparation and issuance of audit reports, as required by this Act or the rules of the Commission, or as may be necessary or appropriate in the public interest or for the protection of investors.
The five members of the PCAOB are appointed by the Securities and Exchange Commission ("the Commission" or "SEC") after consultation with the Chairman of the Board of Governors of the Federal Reserve and the Secretary of the Treasury. Appointment is by majority vote of the five SEC Commissioners. Two PCAOB members must be or have been certified public accountants. After its members are appointed by the SEC, the Board assumes its responsibilities only upon the Commission's determination that the Board has the capacity to carry out the Act's requirements (i.e., that it is properly organized and has appropriate rules and procedures in place). The Commission alone determines whether the Board may "sue and be sued" in any court.
(As for the Commissioners themselves, all five Commissioners are appointed by the President with Senate confirmation. SEC Commissioners can be removed by the President for cause (i.e., for inefficiency, neglect of duty, or malfeasance). The SEC Chairman is selected from among the Commissioners by the President, and serves as Chairman at the President's pleasure. The Chairman often dominates commission policymaking, controls the administrative side of commission business, selects most staff, and sets budgetary policy.)
A member of the Board may be censured or removed from office "for good cause shown" upon a finding by the Commission, after notice and opportunity for a hearing, that the member willfully violated the Act or abused authority, or failed to enforce compliance with a rule or standard without reasonable justification. The Commission is further empowered, by rule, to relieve the Board, consistent with the public interest, of any enforcement authority whatsoever, as well as, by order, to censure the Board and, after notice and opportunity for a hearing, to "impose limitations upon the activities, functions, and operations of the Board" upon finding that the Board has failed to abide by its statutory duties.
"No rule of the Board shall become effective without prior approval of the Commission." To approve a rule, the Commission generally must conduct its own notice-and-comment proceedings. The Commission "shall approve a proposed rule, if it finds that the rule is consistent with the requirements of [the] Act and the securities laws, or is necessary or appropriate in the public interest or for the protection of investors." The Commission is empowered to "abrogate, add to, and delete from" the Board's rules "to assure the fair administration of the [Board], conform the rules promulgated by that Board to the requirements of [the Act], or otherwise further purposes of [the] Act, the securities laws, and the rules and regulations thereunder applicable to [the] Board." The Commission itself is also empowered to promulgate rules in furtherance of the Act.
The Act requires auditors of public companies to register with the PCAOB by submitting applications to the PCAOB, filing periodic reports with the PCAOB, and paying fees to the PCAOB. The SEC may review the PCAOB's accounting support fee rules and denials of regulation applications. The PCAOB may inspect accounting firms and release interim reports detailing any deficiencies in advance of its final conclusions.
When the PCAOB investigates a potential securities law violation, the Board must both inform the Commission and coordinate its activities with the Commission. If a company violates PCAOB rules governing the auditing of public companies, it will be subject to disciplinary actions and sanctions by the PCAOB. Any violation of PCAOB rules "shall be treated . . . as a violation of the Securities Exchange Act of 1934." If the PCAOB determines, after investigation, that an accounting firm has committed a violation, it has the power to impose an appropriate sanction.
All Board adjudications are subject to the Commission's de novo review, upon an immediate stay when an application for review is filed or sua sponte by the Commission. Sanctions imposed by the PCAOB are generally stayed pending Commission review of the inspection report. The Commission is empowered to "enhance, modify, cancel, reduce, or require the remission of a sanction imposed by the Board." The Commission may alter or cancel a sanction imposed by the PCAOB if, "having due regard for the public interest and the protection of investors," the SEC finds that the sanction is "not necessary or appropriate in furtherance of this Act or the securities laws" or is "excessive, oppressive, inadequate, or otherwise not appropriate." Final Commission decisions are reviewable by the Court of Appeals.
Acme Accountants, an accounting firm registered with the Board and subject to an ongoing formal investigation, seeks declaratory and injunctive relief prohibiting the Board from proceeding, arguing that the structure of the Board violates various separation of powers doctrines. What arguments could Acme make, and how would those issues be resolved?
For two possible answers, read the case.
UPDATE: See Michael Greve's article here.