(The article featured below is a selection from PCAOB Reporter, which is available to subscribers of that publication.)

Federal Appeals Court Upholds Constitutionality of PCAOB

A split federal appeals court panel has ruled that the PCAOB is constitutional and rejected the claims of an audit firm inspected by the Board that the SEC rather than presidential selection of Board members ran afoul of the Appointments Clause of the U.S. Constitution. The appeals court concluded that Board members are inferior officers of the U.S. within the meaning of the Appointments Clause and are properly appointed by the SEC. The Sarbanes-Oxley Act's limitation on the SEC's authority providing that Board members can only be removed for cause did not elevate Board members to the status of principal officers of the U.S. worthy of presidential appointment. Despite the "for-cause" removal, the panel said the Act gave the SEC comprehensive and pervasive control of the PCAOB, including the approval of the Board's budget (Free Enterprise Fund v. PCAOB, No. 07-5127, DC Circuit Court of Appeals, August 22, 2008).

The Appointments Clause empowers the President to appoint officers of the U.S., while allowing Congress to vest the appointment of inferior officers with heads of departments. The audit firm argued that PCAOB members are not inferior officers since they are neither appointed nor supervised on a daily basis by principal officers directly accountable to the President. The appeals court rejected this argument, holding that the SEC is a department, the commissioners are heads of a department under the Appointments Clause and that PCAOB members are inferior officers subject to appointment and removal by the SEC. Accordingly, the Sarbanes-Oxley Act provisions creating the PCAOB did not violate the Appointments Clause.

The SEC's power over the PCAOB is broad and complete, the court noted, since no Board rule or standard is promulgated and no Board sanction is imposed without the Commission's stamp of approval. Further, all Board adjudications are subject to Commission review. Any policy decision of the Board is subject to SEC oversight. The SEC can also relieve the Board of any enforcement authority. Audit firms inspected by the Board can seek SEC review of their inspection report. The SEC can modify the Board's investigative authority as it sees fit and may mandate that all decisions regarding enforcement actions be approved by the Commission.

The audit firm's argument that the SEC is not a constitutional department of the federal government capable of appointing Board members was also rejected. The court said that the Commission is "Cabinet-like" because it exercises executive authority over a major aspect of government policy and its principal officers are appointed by the President with the advice and consent of the Senate. The SEC is not a subordinate body attached to an executive department, the court said, but is an independent division of the Executive Branch with certain independent duties and functions.

The commissioners are heads of a department under the Appointments Clause because, as a group, they exercise the same final authority as that vested in a single head of an executive department. Congress gave the SEC rulemaking, investigative and adjudicatory authority. The court emphasized that Congress can authorize multi-member commissions to appoint inferior officers.

The appeals panel also rejected the argument that the legislative creation of the PCAOB violated the separation of powers doctrine by directly encroaching on the Executive Branch's appointment, removal or decision-making authority. The court said that the double for-cause limitation on removal of Board members did not constitute an excessive attenuation of Presidential control of the Board.

The President is not completely stripped of his or her ability to remove Board members. Like-minded SEC commissioners can be appointed by the President, the panel noted, and they can be removed by the President for cause. Board members can be appointed and removed for cause by the commissioners. Although the level of Presidential control over the Board reflects Congress's intention to insulate the Board from partisan forces, the court said this statutory scheme preserves sufficient executive influence over the Board through the Commission so as not to render the President unable to perform his or her constitutional duties.

The Board's creation does not represent an unprecedented congressional innovation, according to the court. The SEC's wide-ranging oversight of the Board was modeled after the rules governing its authority over the self-regulatory organizations in the securities industry, which has existed for over 70 years.