Supreme Court Strikes Down the PCAOB (Sort Of)

Chief Justice Roberts in a 5-4 decision (conservatives v. liberals), declared as unconstitutional the "dual for-cause limitations on the removal of [PCAOB] Board members".   The opinion is here. 

The Court did not enjoin operations of the PCAOB but provide some relief.  See PCAOB at 33 ("In light of the foregoing, petitioners are not entitled to broad injunctive relief against the Board’s continued operations. But they are entitled 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.").  Of course, the Court also essentially fixed the problem.  See Id. at 28 ("Concluding that the removal restrictionsare invalid leaves the Board removable by the Commission at will, and leaves the President separated from Boardmembers by only a single level of good-cause tenure. The Commission is then fully responsible for the Board’s actions, which are no less subject than the Commission’sown functions to Presidential oversight."). 

The main impact of the decision is to eliminate a form of regulation that attempts to bring government bureaucracies closer to the market.  The PACAOB after all was a New York non profit, not a typical government agency.  The decision effectively combines the PACAOB and the SEC, creating a regulatory body that is more bureaucratic and less in touch with the market.  In other words, this opinion must be seen as anti-market in its resolution. 

The majority assumed without deciding that the SEC commissioners could only be removed "for cause."  (The statute is silent).  The dissent was more direct on the point.  As Justice Breyer stated:

• It is certainly not obvious that the SEC Commissioners enjoy “for cause” protection. Unlike the statutes establish-ing the 48 federal agencies listed in Appendix A, infra, the statue that established the Commission says nothing about removal. It is silent on the question. As far as its text is concerned, the President’s authority to remove the Commissioners is no different from his authority to remove the Secretary of State or the Attorney General. See Shurtleff, 189 U. S., at 315 (“To take away th[e] power of removal . . . would require very clear and explicit lan-guage. It should not be held to be taken away by mereinference or implication”); see also Memorandum from David J. Barron, Acting Assistant Attorney General,Office of Legal Counsel, to the Principal Deputy Counsel to the President: Removability of the Federal Coordinatorfor Alaska Natural Gas Transportation Projects, p. 2 (Oct. 23, 2009), online at http://justice.gov/olc/2009/gas-transport- project.pdf (“[Where] Congress did not explicitly providetenure protection . . . the President, consistent with . . .settled principles, may remove . . . without cause”); The Constitutional Separation of Powers Between the Presi-dent and Congress, 20 Op. Legal Counsel 124, 170 (1996) (same).

• Nor is the absence of a “for cause” provision in the stat-ute that created the Commission likely to have been inad-vertent. Congress created the Commission during the 9-year period after this Court decided Myers, and therebycast serious doubt on the constitutionality of all “for cause”removal provisions, but before it decided Humphrey’s Executor, which removed any doubt in respect to the con-stitutionality of making commissioners of independent agencies removable only for cause. In other words, Con-gress created the SEC at a time when, under this Court’sprecedents, it would have been unconstitutional to make the Commissioners removable only for cause. And, during that 9-year period, Congress created at least three majorfederal agencies without making any of their officers removable for cause. See 48 Stat. 885, 15 U. S. C. §78d(Securities and Exchange Commission), 48 Stat. 1066, 47 U. S. C. §154 (Federal Communications Commission); 46Stat. 797 (Federal Power Commission) (reformed post-Humphrey’s Executor as the Federal Energy Regulatory Commission with “for cause” protection, 91 Stat. 582, 42 U. S. C. §7171). By way of contrast, only one month after Humphrey’s Executor was decided, Congress returned toits pre-Myers practice of including such provisions instatutes creating independent commissions. See §3, 49Stat. 451, 29 U. S. C. §153 (establishing National Labor Relations Board with an explicit removal limitation).

The Supreme Court and the PCAOB (Oral Argument): A Prediction (Part 4)

The prediction?

The PCAOB will not be found unconstitutional. 

The transcript, briefs, and other primary materials can be found at the DU Corporate Governance web site.

The Supreme Court and the PCAOB (Oral Argument): The Elephant in the Room (Part 3)

We have noted on this Blog that the source of the  "for cause" limits on the removal of SEC commissioners is at best unclear.  Unlike the FTC, the enabling statute is silent.  The parties largely assumed away the issue for purpose of the appeal.  Yet the issue may not be so easily resolved. 

The restrictions on the President's ability to remove SEC commissioners is a core component to Petitioner's argument.  If the President had broad authority to remove SEC commissioners, he/she could effectively control the actions of the PCAOB through this authority.  Moreover, its not enough to contend that the SEC commissioners can only be removed for cause.  The definition of "for cause" must be narrow enough to deprive the President of the ability to remove commissioners when he/she thinks they have not acted with sufficient alacrity with respect to PCABO behavior.

In other words, the argument for unconstitutionality is fundamentally premised on the President's inability to remove except for cause and a narrow reading of the circumstances when cause can be found.  The issue came up often in oral argument.  Perhaps the clearest example occurred in connection with a colloquy between Justice Kennedy and Solicitor General Kagan:

• JUSTICE KENNEDY: I want to ask -- I want to ask one thing: You want us to imply or find -- or you want us to infer from the statute that there's a power in the President to remove SEC commissioners for cause? You want us to find that that is implied in the statute?

• GENERAL KAGAN: Justice Kennedy, the conventional understanding, really, ever -- ever since Humphrey's Executor, is that SEC commissioners are subject to a for-cause removal provision. And the --

• JUSTICE KENNEDY: All right. What is --what is the authority for us to find that there is an implication in the statute to remove just for cause? There is -- wouldn't that be unique in our precedents?

• GENERAL KAGAN: I think that, if I understand the question correctly, I think that the --the implication about --

• JUSTICE KENNEDY: I mean, if there is a removal power implied, why isn't it removal for all purposes -- why can it be limited to just for cause? What authority do we have to do that?

• GENERAL KAGAN: Well, I think that the understanding about the SEC commissioners is that the SEC commissioners were, essentially, the same as the FTC commissioners, which, under -- which, under Humphrey's, were removable only for cause, and as I believe --

• JUSTICE SOTOMAYOR: But that's because the

• GENERAL KAGAN: Yes, but -- you are exactly right, and it's a -- it's a perplexity of this law, but for many, many decades, everybody has assumed that the SEC commissioners are subject to the same for-cause removal provision, and the government has not contested that in this case, nor has Mr. Carvin.

Those favoring the PCAOB need not resolve the issue.  They can assume a for cause removal restriction and a narrow interpretation of the phrase yet conclude that the PCAOB is constitutional. 

Those wanting to strike down the PCAOB, however, have no such luxury.  Assuming predicate interpretations of a statute (that for cause was the appropriate standard and that it was a narrow interpretation) that may or may not ultimately be accurate is not a sound basis for striking down the PCAOB. 

It seems, therefore, that the opponents will have to resolve these issues.  Yet they were not briefed.  They will require an exegesis into statutory authority at the time of the adoption of the Exchange Act.  It seems unlikely that a majority on the Court will resolve these issues, suggesting that there will not be a majority on the Court to strike down the PCAOB. 

The transcript, briefs, and other primary materials can be found at the DU Corporate Governance web site.

The Supreme Court and the PCAOB: Oral Argument (Part 2)

Oral argument generated considerable commentary.  Some saw the case as dividing along traditional conservative and liberal lines, with Justice Kennedy playing the traditional role of swing vote.  Moreover, the Washington Post went further and suggested an outcome:  "The questioning indicated that Justice Anthony M. Kennedy might cast the deciding vote; he seemed skeptical of arguments that the SEC's control of the board was pervasive." 

A review of the transcript, however, suggests that in fact the Court may not be so divided.  Or, perhaps a better way to say it, is that the Court factions are not so unified.  The conservatives on the Court had a hard time finding a theory that would allow, in a facial challenge, for a determination that the PCAOB was unconstitutional.

Petitioners primarily argued that the PCAOB had unreviewable discretion through its ability to initiate investigations. Justice Scalia seemed unconvinced that the SEC could not prevent improper investigations through its rulemaking authority.  Although counsel for Petitioner denied that the SEC had the authority, the Solicitor General argued otherwise.  As she noted: "But [the SEC] also has authority to set the ground rules by which the Accounting Board does anything and everything. It can say tomorrow -- it can promulgate a rule and say all inspections have to be approved by us, all investigations."  In other words, the one area of concern about unreviewable discretion by the PCAOB was in dispute.  Unless the Court is prepared to resolve the issue, it will likely have to accept the Solicitor General's characterization. 

Justice Kennedy asked only a few questions, at least some of which suggested that he was not impressed with the concern over the PCAOB's investigatory authority.  In the early moments of the argument, he essentially made clear that he considered the "harm" to accounting firms as a result of any investigatory discretion by the PCAOB as a "cost of compliance."  The characterization seemed to suggest that he viewed Petitioners' argument about harm as nothing more than a routine business expense, hardly a basis for ruling a statute unconstitutional. 

Justices Alito and Roberts worked hard to find places where the PCAOB had discretion that was effectively unreviewable.  They suggested that the PCAOB was unique. They questioned counsel about the budget and about salaries paid to board membes.  Jefferey Lamken provided strong responses, repeating over and over that even salaries and budget were subject to SEC oversight.  In the end, neither Justice was able to get a clear example of an aspect of the PCAOB's function that wasn't under the control of the SEC. 

In the end, the PCAOB will hold the votes of the four liberals.  For the conservatives to find the PCAOB unconstitutional, they will have to conclude that the president exercised insufficient control over the PCAOB.  That in turn will require a finding that the double layer of removal authority is per se unconstitutional and that the SEC lacked plenary control over the PCAOB.  While there will be some support for the former, the latter, particularly given the high level of SEC control and the uncertainty of the SEC's rulemaking authority (which arguably could be used to remove even the authority to initiate certain investigations), will be difficult to conclude.

The transcript, briefs, and other primary materials can be found at the DU Corporate Governance web site.

The Supreme Court and the PCAOB: Oral Argument (Part 1)

Oral argument was held in FEF v. PCAOB, a case challenging the constitutionality of the PCAOB.  The case has often been discussed as if it involved a frontal challenge to all of SOX.   Thus, the Wall Street Journal Law Blog asked:  "Whither Sarbanes-Oxley? Come June, will the law exist in its current form or will it have to be dismantled or reconstituted, the result of a hostile Supreme Court ruling?"

The approach is little more than hyperbole.  Whatever happens in the case, SOX, particularly Section 404 and the heightened governance requirements, will remain unaltered.  At most, Congress will have to merge the PCAOB into the Securities and Exchange Commission, something that all of the parties concede is constitutional. 

A critical issue in the case turns on the constitutionality of the limits on the president's right to remove members of the PCAOB board.  The president has no direct removal authority.  Only the Securities and Exchange Commission can remove them and only for cause.  At the same time, Commissioners on the SEC can only be removed by the president for cause.  (Although as we have noted, and Justice Breyer pointed out at oral argument, there is no explicit provision that limits the president's ability to remove SEC commissioners only for cause).  The president does have plenary authority to designate the chairman. 

The Government took the position that the PCAOB was subject to plenary control by the SEC.  It was, therefore, functionally no different than a branch of the Commission.  The Commission had the right to review all rules, penalties in enforcement proceedings, and even subpoenas.  As such, the PCAOB was no more independent from the president than the SEC itself.  As Solicitor General Kagan noted:

• Mr. Chief Justice, removal is just a tool. Removal is not the ultimate constitutional question. The ultimate constitutional question is the level of presidential control, and the presidential control here is exactly the same with respect to the board's activities as it is with respect to the SEC staff's activities.

The only real exception to the plenary control argument was the right to begin an investigation.  As this exchange between Justice Breyer and counsel for Plaintiff noted:

• JUSTICE BREYER: But I've got one thing on my list. I'm looking to what they control, can't control, the commission. And so far I've written that in your view the commission can investigate people without subpoenas and the commission can do nothing about it, okay? That's one.

• MR. CARVIN: Yes.

• JUSTICE BREYER: Now, what's two?

• MR. CARVIN: Well, I think that that is the main point.

For the Supreme Court to strike down the PCAOB, a majority of the Court will have to find that this degree of discretion violates the Constitution.  They will have to find that the imposition of something described in oral argument as a "cost of doing business" results in a violation of the Constitution. 

The transcript, briefs, and other primary materials can be found at the DU Corporate Governance web site.

FEF v. PCAOB: Off to the Supreme Court

As expected, plaintiffs have filed a cert petition in the PCAOB case.  Reading it over, one would think this the single most important case of constitutional magnitude in a lifetime.  In fact, it largely turns on whether Congress can limit the removal authority of persons within independent agencies.  The practice is relatively common.  As the PCAOB noted in its brief opposing rehearing en banc:

• The Inspector General of the Postal Service is an inferior officer. See 5 U.S.C. App. 3 § 8G(f );About the USPS OIG, at http://www.uspsoig.gov/about.htm. But he is removable only for cause by the Governors of the Postal Service, who in turn are removable only for cause. 39 U.S.C. § 202(a)(1), (e)(3). Likewise, the Chief Actuary of the Social Security Administration is an inferior officer. See 42 U.S.C. § 902(c)(1); Office of the Chief Actuary, at http://www.ssa.gov/ OACT/actuaries/organization.html. He too is removable only for cause, and the Commissioner to whom he reports is removable only for cause. 42 U.S.C. § 902(a)(3), (c)(1). Finally, many independent agencies have administrative law judges (ALJs) who are subject to for-cause removal protections. Although some are mere employees, others are clearly inferior officers. ALJs in the Federal Mine Safety and Health Review Commission, for example, are inferior officers because their decisions are final rather than recommendatory and are subject only to limited review. See 30 U.S.C. § 823(d)(1), (2)(A)(ii)(I); Landry, 204 F.3d at 1133-34. All of those ALJs, however, are removable only for cause by officers who in turn are removable only for cause. 30 U.S.C. § 823(b)(1), (2) (incorporating 5 U.S.C. § 7521); 5 U.S.C. § 1202(d). (ALJs cannot be distinguished on the grounds that agencies can choose whether to use them, and that their decisions are subject to agency review. See 537 F.3d at 699 n.8 (Kavanaugh, J., dissenting). 

Plaintiffs' brief is once again written in an unfortunately non-gender neutral manner.  Mary Schapiro, the incoming chair of the SEC, would no doubt be surprised to learn on page 17 that "he serves as Chairman 'at the pleasure of the President.'"  She would likewise be surprised to hear that, in creating the PCAOB,  Congress denied the Chairman "his traditional statutory authority to 'appoint and supervise'" members of the body.  And this is not the only example.  On this basis alone the petition deserves to be denied.

We will wait for the government's response before venturing a prediction on the merits.

The petition is posted on the DU Corporate Governance web site.

FEF v. PCAOB: The Supporting Material

Yesterday we noted that the DC Circuit denied en banc review of the case upholding the constitutionality of the PCAOB.  The decision was by a razor thin margin of 5-4.  We note only that all of the filings/pleadings in the case, including the materials filed before the DC Circuit in connection with the petition for rehearing en banc can be found on the DU Corporate Governance web site.

FEF v. PCAOB: En Banc Review Denied, On to the Supreme Court

The DC Circuit decided, by a 5-4 vote, not to hear the PCAOB case en banc (we have produced the order below).  Judge Kavanaugh, who dissented in the panel opinion got support for en banc review from Chief Judge Sentelle, and Judges Ginsburg and Griffith, one shy short of the number needed.  The case now will no doubt be off to the Supreme Court.  We await Plaintiffs' petitions for certiorari.

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
____________
No. 07-5127 September Term 2008
06cv00217
Filed On: November 17, 2008

Free Enterprise Fund and Beckstead and
Watts, LLP,
Appellants

v.

Public Company Accounting Oversight Board,
et al.,
Appellees

BEFORE: Sentelle*, Chief Judge, and Ginsburg*, Henderson, Rogers, Tatel,
Garland, Brown, Griffith*, and Kavanaugh*, Circuit Judges

O R D E R

Appellants’ petition for rehearing en banc and the responses thereto were
circulated to the full court, and a vote was requested. Thereafter, a majority of the
judges eligible to participate did not vote in favor of the petition. Upon consideration of
the foregoing, it is

ORDERED that the petition be denied.

FOR THE COURT:
Mark J. Langer, Clerk
BY: /s/
Michael C. McGrail
Deputy Clerk

* Chief Judge Sentelle, and Circuit Judges Ginsburg, Griffith, and Kavanaugh would
grant the petition for rehearing en banc.

FEF v. PCAOB: Plaintiffs Seek Reconsideration (In a Non-Gender Neutral Manner)

The DC Circuit consists of 13 judges, three of whom are women.  The plaintiffs in this case, however, have trouble recognizing this.  At oral argument, there was a small repartee over the improper use of the male pronoun by plaintiff. 

With that in mind, we were a bit surprised to see the motion for reconsideration written without regard to gender neutrality.  This was particularly (but not always) true with respect to references to the president.  Thus, according to the brief:

• Here, the President has been "completely stripped" of his removal power.  Brief, at 4.
• the President has no power to direct the SEC to exercise its discretion to remove a Board member, any more than he could direct the SEC to follow his wishes . . . Brief, at 5. 
• The President's ability to "appoint" does not confer influence over how independent agencies exercise their discretionary power . . . because it is not coupled with the power to remove for failure to follow his policy wishes.  Brief, at 6 n. 3 
• Congress specifically denied the President this power by stripping the Chairman of his heretofore exclusive power to appoint and remove subordinates . . .    Brief, at 6 n. 3 
• "Equally important, even if the President could totally control the SEC through his indirect influence, that still would not enable him to exert any policy influence over Board members who were executing the law in a way he viewed as destructive . . . Brief, at p. 7
• Even assuming arguendo that enhanced SEC control over the board could somehow ameliorate stripping the President of his Article II power, Brief, at 10
• and the President is powerless to switch that power to an agency over which he exercises sufficient control.
• An executive official is an inferior officer only if his work is . . . Brief, at 12.
• Where, as here, an officer cannot be removed for purising policies at odds with the agency's desired policies, then he is not subject to . . . 

We didn't bother including the non-neutral references that were contained in quotes although careful drafting could eliminate these as well.  Now, one might argue that it is acceptable to speak of the president using only the male pro-noun since there have only been male presidents.  First, there were plenty of other non-gender neutral references that didn't involve the president.  Second, the fact that presidents have always been male will change (as it could easily have in this election cycle).   Finally, the term president is generic.  When referring to a generic office, gender neutrality is always preferred.   

We should note out of a sense of completeness that, other than some quotes from Morrison, Plaintiffs did speak in a gender neutral fashion once.   As the brief noted: 

• First, the SEC is permitted to remove a PCAOB member only if it finds, after a hearing on the record, that the member willfully violated the Act or Board rules, willfully abused his or her authority, or unreasonably failed to enforce compliance with the Act

In other words, in one instance, for members of the PCAOB, the brief speaks in a gender neutral manner.   Surely it would have been possible to do the same throughout the brief.  And, its a little surprising that a dean of a law school would sign off on a brief written in this fashion, where 48% of his students in the 2008 entering class are women.

FEF v. PCAOB: Plaintiffs Seek Reconsideration

The challenge to the constitutionality of the PCAOB lives on.  Plaintiffs lost at the trial level and lost at the court of appeals.  Before taking a stab at cert, they have filed a petition for rehearing and rehearing en banc.  The missive is mostly a rehash of the issues already litigated and resolved, with special prominence given to the only judge so far to agree with their arguments (Judge Kavanaugh).  

The critical issue is the double layer of removal restrictions.  Members of the PCAOB are appointed by the SEC and can only be removed by the SEC for cause.  It is this attenuated influence that is at the heart of the constitutional challenge. Plaintiffs pose the proper question.  They argue that "the President has been 'completely stripped' of his removal power."  Thus, the president can only remove rogue board members by somehow forcing the SEC to do it.  

For the plaintiffs to win, the en banc court will have to accept that the double layer of restrictions is per se unconstitutional, irrespective of the duties assigned to the PCAOB.  After all, Morrison, the key case in this area, defined the test as whether the restriction on removal interfered with the president's ability to carry out his or her constitutionally assigned duties.  Overseeing accounting firms is not a very big or important part of the president's duties.  

The petition is filed on the DU Corporate Governance web site.

The PCAOB and the Constitutionality of Restrictions on Removal

The most significant constitutional question in the case concerns the double layer of removal restrictions. As the DC Circuit described:   "[T]he 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."   There isn't much law in this area and for now the most applicable precedent is Morrison v. Olson, 487 U.S. 654 (1988).  Morrison involved the constitutionality of independent counsel.  Counsel was appointed by a panel of judges and could only be removed for cause by the attorney general.  

The Supreme Court upheld the removal restriction emphasizing that the independent counsel was a position with limited jurisdiction (the panel of judges assigned the relevant matter for investigation) and limited duration (it went away once the investigation was completed).  Although these were the factors emphasized by the Court, it wasn't really about limited jurisdiction or tenure.  It was about whether the task performed by independent counsel somehow involved a critical executive  function.  As the Supreme Court concluded:  "we simply do not see how the President's need to control the exercise of that discretion [the discretion exercised by the independent counsel] is so central to the function of the Executive Branch . . . "  In other words, restrictions on removal of employees in the executive branch are permissible if they are imposed on personnel who are not that important to the function of the presidency.

That accurately describes the PCAOB.  Even though the jurisdiction is arguably broader and the tenure longer (at least more definite), the task of regulating independent auditors isn't central to the function of the president. 

But even if the office can be subject to removal restrictions, that does not mean any restrictions will pass constitutional muster.  If for example Congress were to provide that removal could only occur with the advise and consent of the Senate, this would be unconstitutional, even if it applied to non-central personnel.  In Morrison, the Supreme Court concluded that Congress could limit removal of non-central personnel to good cause where the cause was exercised by the Attorney General.  Presumably, had Congress instead prohibited removal by the president (or anyone appointed by the president), this would have been unconstitutional.  The president must have at least some residual right to police the actions of the members of his or her branch, particularly where they engage in misconduct.

The issue in the PCAOB case, therefore, is whether the double removal restriction was so severe as to deprive the president of any ability to supervise employees in his/her own branch.  One could imagine, for example, that a quadruple removal restriction (four layers of for cause removal restrictions) would make the president's authority to remove so attenuated as to deny it completely.  That was the question in this case:  Whether the president's ability to remove was so attenuated, it effectively did not exist.  Moreover, the analysis might change somewhat depending upon the importance of the non-central official at issue.

In this case, though, the answer is no.  The SEC has extensive supervisory authority over the PCAOB.  The authority constrains the actions of the PCAOB, limiting its discretion.  This oversight is a form of presidential supervision since the commissioners on the SEC are appointed by the president.  Moreover, if real misconduct occurred and the SEC did nothing, the president likely could remove SEC commissioners (for cause) and appoint those who would take the necessary steps against the PCAOB.  Its a blunt authority to say the least.  The president won't be likely to remove members of the Commisson for failing to act against the PCAOB except in the most extreme circumstances.  But that's the point.  In the most extreme circumstances, the president could intervene.  Short of that, the structure requires that auditing standards  be kept above the political fray.

The PCAOB and Its Unique Regulatory Function

We are discussing the constitutionality of the PCAOB, a matter recently (if not temporarily) resolved by the DC Circuit.  I have been teaching administrative law this semester and recently discussed this case as well as the relevant Supreme Court cases with students.  These posts are a result of thoughts coming from class discussion. We will have two of them on this subject today.

The DC Circuit held that the PCAOB, as a matter of administrative structure, was constitutional.  There were a plethora of issues but the main one was the double layer of for cause removal restrictions.  Congress set up the PCAOB so that the members were appointed by the Securities and Exchange Commission, not the President.  Moreover, members of the board could only be removed for cause by the Commission.  More specifically, the Commission had the right to remove board members for failing to enforce their own rules.

The PCAOB is something like a self regulatory organization, an approach to regulation that has long been present in the securities markets, with the stock exchanges an example.  But the model has problems, in particular the problem of enforcement.  Self regulators have an incentive to go light on their own.  This is not a new problem.  The legislative history to the Exchange Act is replete with discussions of this problem in connection with the NYSE.  Indeed, in adopting the Act, Congress refused to allow the NYSE to regulate the periodic reporting process because of the problem of enforcement and instead gave the authority to the SEC.  Recall that in 1934, Section 13(a) only applied to exchange traded companies.

Because the SEC appoints the members of the PCAOB, rather than the president, this effectively limits the authority of the president over the regulation of auditors.  While this might not sound like any great loss, one could imagine what auditing standards would look like if the system became imbued with excessive political interference (imagine what would have happened with the dispute over the standards for conforming with the attestation requirements of SOX Section 404(b) had the process been more political). 

At the same time, by only allowing the Commission to remove board members for cause, Congress unquestionably was trying to create a regulatory body that was to some degree independent of the regulators.  In other words, Congress didn't want auditor standards set by the president but also didn't want auditor standards set by the SEC.  Instead, Congress wanted an organization that was largely free of bureaucratic impediments and closer to industry.  At the same time, however, the right of the Commission to remove board members for non-enforcement of the rules of the PCAOB meant that the PCAOB couldn't get too close to industry.  It is an interesing experiment in government.  The approach, as the litigation illustrates, raises a number of constitutional questions.

With that in mind, we will do a second post today on the constitutionality issue.

Free Enterprise Fund v. PCAOB: Regulation, the Free Market, and the Constitution (The Dissent and Minimizing the Impact)(Part 18)

We offer a final note.

There is no doubt at this Blog that the litigation has not yet ended. We fully expect the plaintiffs to file a petition for ceriorari and see if they can attract the attention of the high court. Certainly, the dissent has written one of those opinions designed to attract the attention of those on the Supreme Court most concerned with limits on executive authority. But having said that, we'll be surprised if Justice Scalia is able to convince three others (cert requires four justices to assent) to join him. Why?

First, Judge Kavanaugh is caught in a conundrum. On the one hand, he wants to make the case one of critical importance, a direct threat to the Republic. On the other hand, he knows that he must delicately walk around the independent agency issue. He cannot issue a decision that provides ammunition to those wanting the challenge the constitutionality of independent agencies. That ship has sailed and there is no going back. Consequently, he starts by opining on the importance of the decision but ends with an explanation of the unimportance of the decision. He points out that the decision does not impact the independent agencies and, in fact, only impact the PCAOB. He's not quite right on that, as we have noted, but it sure reduces the power of any argument that the case, if left standing, will disrupt our system of government.

Second, although wanting to defend executive authority, the Supreme Court won't have the executive on its side. It has been the DOJ that has vigorously defended the constitutionality of the PCAOB. Judge Kavanaugh was clearly troubled by this. First, he tries to minimize the government's involvement.

• the Department of Justice representing the United States as intervenor has defended the constitutionality of this statute. To be sure, the defense has been rather tentative; at oral argument, the superb counsel from DOJ refused to say that the structure of the PCAOB would be permissible in any analogous situation, strongly implying that the Executive Branch’s position is a ticket good for this train and this day only. In any event, the Executive Branch has defended the statute as consistent with Article II. This is reason for respectful consideration.

The written transcript suggests a vigorous defense of the Act by the attorney for the DOJ, Mark Stern. 

Judge Kavanaugh then tries to make the case that the DOJ really didn't really believe its own position, that it was a matter of political expediency.

• History tells us that Executive Branch prerogatives have, in some instances, taken a backseat to the President’s other more immediate policy, legislative, or political priorities. The United States as intervenor has argued that the PCAOB is better from a Presidential control perspective than the private self-regulatory accounting organizations that previously existed to regulate the accounting industry. This is an odd argument as a matter of constitutional law. The fact that the President would have less control over a private organization than over an Executive Branch entity is both obvious and irrelevant. It certainly does not excuse compliance with Article II’s principles regarding Presidential appointment and removal of executive officers.

In the end, he is left with the only real response. He disagrees with the DOJ and, as a result, doesn't intend to follow the reasoning.    But added to this is the notion that it falls on Judge Kavanaugh to defend the Constitution, at least where the President won't. 

• But as the Supreme Court has stated when this situation has arisen before, the Judiciary cannot defer to the Executive Branch in justiciable cases affecting individual rights simply because the Executive Branch does not assert its Article II prerogatives. The primary reason, as the Court has explained time after time, is that the separation of powers protects not simply the office and the officeholders, but also individual rights. The point was captured well by Justice Blackmun in his opinion for the Court in Freytag: “In reaching this conclusion, we note that we are not persuaded by the Commissioner’s request that this Court defer to the Executive Branch’s decision that there has been no legislative encroachment on Presidential prerogatives . . . . The structural principles embodied in the Appointments Clause do not speak only, or even primarily, of Executive prerogatives simply because they are located in Article II. . . . The structural interests protected by the Appointments Clause are not those of any one branch of Government but of the entire Republic.” So too here.

The Justice Department is not always right but in this case, a potentially delicate issue dealing with separation of powers, the Supreme Court will get no help from the supposedly aggrieved branch of government.

Finally, even if the Supreme Court wanted to examine whether a somewhat more severe restriction on the president's removal authority was constitutional, this is not the right case, at least for those wanting to strengthen executive authority.  The case, after all, involves the regulation of independent auditors.  In other words, unless the Court was willing to issue a per se rule that these types of restrictions were always unconstitutional (like the way it struck down legislative veto in Chadha), this case simply doesn't intersect in any meaningful way with the president's constitutionally assigned duties.  

We have a limited track record in predicting decisions by the Supreme Court but so far are one for one, having anticiapted the outcome in Stoneridge.  We will therefore offer a prediction in this matter.  A petition for certiorari will be filed and it will be denied.

Free Enterprise Fund v. PCAOB: Regulation, the Free Market, and the Constitution (The Dissent and Minimizing the Impact)(Part 17)

 We are discussing the decision, issued today, by the DC Circuit, upholding the constitutionality of the PCAOB.  It was a 2-1 decision. 

The dissent goes out of its way to minimize the impact of its reasoning.  Striking down the PCAOB (primarily because of the limitations on the president's removal authority) would, according to the dissent, have little effect and be easily corrected.  

• Third , to reiterate, the PCAOB is uniquely structured, and a judicial holding invalidating it would be uniquely limited to the PCAOB. And Congress could easily fix the constitutional flaws by, for example, making PCAOB members subject to Presidential appointment with the advice and consent of the Senate and therefore removable by the President. Cf. Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, 122 Stat. 2654 (2008) (creating new “independent” federal regulator of Fannie Mae and Freddie Mac appointed by President with advice and consent of Senate and removable for cause by President). Alternatively, Congress could fix the problem by making the PCAOB a truly subordinate part of the SEC – for example, by giving the SEC express authority to direct and supervise all Board actions and to fire Board members at will. In such a structure, the Board would not differ from any other inferior officers in the SEC. In the meantime, in my judgment, the Board’s structure violates the Constitution of the United States. 

We actually said the same thing on this Blog, at least with respect to the methods of fixing the board, but very much disagree with the efforts to minimize the potential impact of the decision.  First, the analysis is wrong to suggest that only the PCAOB will be impacted by the decision.  The existence of a double layer of for cause removal is more common than the dissent suggests. 

Second and more importantly, such a decision would essentially lock the government into a model of regulation that requires every regulatory body to be a full blown federal agency.  The PCAOB has an attempt to create a regulatory model with private sector sensibilities.  As a result, the PCAOB had strong ties to the private sector.  Were the PCAOB to be transformed into an independent agency, it would, as we wrote, "likely be less responsive to the private sector and would have the attendant problems associated with a traditional bureaucracy."  In other words, the implications of this case are not so much about the impact on other existing agencies but on the nature of regulation.  If the dissent becomes the law, a form of regulation that tries to more closely intersect with the private sector will be eliminated.  This would ultimately be detrimental and, frankly, not in the best interests of the private sector. 

The opinion (and the supporting documents) are here. 

Free Enterprise Fund v. PCAOB: Regulation, the Free Market, and the Constitution (The DC Circuit Rules: The PCAOB Is Constitutional)(Part 16)

The critical issue, as we noted on this Blog, was the right of Congress to restrict the president's removal authority. The commissioners of the PCAOB were only subject to removal by the SEC for cause. The SEC, in turn, is an independent agency. Thus, removal by the president was subject to two layers of limitations. Unlike appointments, the Constitution is silent on removal. As a result, removal is addressed through application of separation of powers doctrine, an amorphous area to say the least. With respect to removal limitations, the Supreme Court is relatively clear that Congress can impose limitations on removal where it gets to participate in the removal decision. Thus, requiring advise and consent of the Senate before an executive branch employee can be removed is unconstitutional.

Second, assuming Congress stays out of it, limitations on removal are permissible if they do not prevent the president from performing his or her "constitutionally assigned duties." Morrison, 487 U.S. at 696. This is a highly underdeveloped area. But in Morrison, the Supreme Court essentially reaffirmed the holding in Humprhey's Executor. That was the case that upheld the restrictions imposed by Congress on the president's abilty to remove commissioners from the Federal Trade Commission. Congress allowed the president to remove them only "for cause." In other words, the Supreme Court held that Congress could limit removal authority by the president for officials that have wide ranging authority without it interfering with the president's "constitutionally assigned duties." Given this blessing of Humphrey's Executor, it is hard to make an argument that limitations on removal of commissioners of the PCAOB somehow interfere with the president's constitutionally assigned duties.

Nonetheless, the double layer of removal restrictions presents at least a unique set of circumstances. The majority addressed the issue in succinct fashion:

• The Fund does not assert that Congress or the judiciary have directly encroached on the Executive Branch’s appointment, removal, or decision making authority by aggrandizing their own powers. Instead, the Fund’s separation of powers challenge is premised on the contention that the Act constitutes an excessive attenuation of Presidential control over the Board. The crux of the Fund’s challenge – that the double for-cause limitation on removal makes it impossible for the President to perform his duties – is a question of first impression as neither the Supreme Court nor this court has considered a situation where a restriction on removal passes through two levels of control. But the Fund’s categorical, bright-line approach conflicts with the Supreme Court’s case specific reasoning in Morrison, which emphasized that there are “several means of supervising or controlling [Presidential] powers,” 487 U.S. at 696. The removal power thus does not operate in a vacuum; rather it is one of several criteria relevant to assessing limits on the President’s ability to exercise Executive power.

The dissent vociferously disagrees.  As the opinion notes:  "[T]he 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."  In other words, the dissent doesn't like this type of restriction on the president's removal authority.  Its true that the structure is unique.  But the broader question is whether increased restrictions on the president somehow interfere with constitutionally mandated duties.  It is a hard case, unless adopting a per se rule, to argue that increased interference with the president's ability to manage the accounting profession somehow interferes with constitutionally mandated duties. 

The opinion (and the supporting documents) are here. 

Free Enterprise Fund v. PCAOB: Regulation, the Free Market, and the Constitution (The DC Circuit Rules: The PCAOB Is Constitutional)(Part 15)

 The two main challenges were to the appointment of PCAOB members and the limits on their removal. In the former case, it was the SEC that appointed the members, not the President. Resolution of this issue came down to whether the limitation on presidential appointment violated the Appointments Clause. That in turn came down to whether members of the PCAOB were Principal (as opposed to inferior) officers. Resolution of that issue largely depended upon the issue of supervision. See Edmond v. United States, 520 U.S. 651, 662 (1997)("Generally speaking, the term 'inferior officer' connotes a relationship with some higher ranking officer or officers bleow the President: Whether one is an 'inferior' officer depends upon whether he has a superior.").

The PCAOB is subject to extensive supervision by the SEC, with all rules and sanctions subject to review by the agency. As such, the PCAOB was subject to the oversight of a superior. Plaintiff argued that there were places where the PCAOB could intitiate actions without supversion. Thus, for example, the PCAOB could intitiate an investigation without SEC approval although any sanctions ultimately were subject to SEC oversight. The majority rejected the argument.

• Consequently, the Board’s work is necessarily “directed and supervised at some level” by the Commission. Notably for purposes of this facial challenge, the Act subjects Board members to greater supervision than the Coast Guard judges in Edmond, whom the Supreme Court held were inferior officers even though supervision of the judges was fractured between two different bodies, id. at 664, and their decisions were not subject to de novo review, id. at 665. Contrary to the Fund’s suggestion, the fact that the Board is charged with exercising extensive authority on behalf of the United States does not mean that Board members must be appointed by the President, for principal as well as inferior officers, by definition, “‘exercis[e] significant authority pursuant to the laws of the United States.” Instead, what is key under the Edmond analysis is the fact that Board members “have no power to render a final decision on behalf of the United States unless permitted to do so by other Executive officers.” The Act vests a broad range of duties in the Board, 15 U.S.C. § 7211(c), but its exercise of those duties is subject to check by the Commission at every significant step.

The main argument, however, that took up most of the space in the majority and dissenting opinion, came back to one issue: The restriction on the president's ability to remove commissioners of the PCAOB. (It is the Commission that has this authority and may only remove for cause). Thus, the dissent essentially conflated appointments and removal authority. Limits on removal meant unconstitutional appointment. The majority rightfully noted the central weaknesses in the argument:

• The Supreme Court has expressly permitted legislatively imposed limitations on executive officers’ removal authority: We have no doubt that when congress, by law, vests the appointment of inferior officers in the heads of departments, it may limit and restrict the power of removal as it deems best for the public interest. The constitutional authority in congress to thus vest the appointment implies authority to limit, restrict, and regulate the removal by such laws as congress may enact in relation to the officers so appointed. The head of a department has no constitutional prerogative of appointment to offices independently of the legislation of congress, and by such legislation he must be governed, not only in making appointments, but in all that is incident thereto.

The critical issue was removal (as even the discussion of the appointments issue illustrates). We will discuss that issue next.

The opinion (and the supporting documents) are here.

Free Enterprise Fund v. PCAOB: Regulation, the Free Market, and the Constitution (The DC Circuit Rules: The PCAOB Is Constitutional)(Part 14)

The DC Circuit has ruled.  By a 2-1 decision, the PCAOB is constitutional, upholding the one provision of Sarbanes Oxley that has been challenged.  The opinion (and the supporting documents) are here.  The decision was a gender split, the  two women on the panel (Rogers & Brown) upholding the PCAOB's constitutionality, Kavanaugh, the one male, dissenting.  We will provide some commentary as we digest the 92 page opinion.

Free Enterprise Fund v. PCAOB: Regulation, the Free Market, and the Constitution (The Countdown)(Part 13)

The DC Circuit has been sitting on the PCAOB case since last April (oral argument was on April 15).   It's our understanding that the court tries to issue opinions for the prior term by August 1.  Obviously, that deadline hasn't been met.  We also understand that the court usually issues opinions on Tuesdays and Fridays at 11:00 am.  To the extent that the opinion comes out this month, we are looking at August 15, 19, 22, 26 or 29. 

It is potentially a complicated case which might explain the delay.  The more likely explanation is a divided panel. 

Free Enterprise Fund v. PCAOB: Regulation, the Free Market, and the Constitution (Be Careful What You Wish For)(Part 12)

FEF v. PCAOB is a case that tests a new model of self regulation.  To the extent that the DC Circuit strikes down the model, the Plaintiffs may well find the consequences not to their liking. 

When the suit was filed, there was no doubt hope that a decision finding the PCAOB unconstitutional would have spelled the demise in the organization. With a Republican Congress overseen by a Republican president, and the Enron scandal having receded into the past, there was little stomach for additional regulation.  A legislative fix for the PCAOB, therefore, was highly problematic.  A victor, in short, meant deregulation.    

But times have changed.  There is now a Democratic Congress and, increasingly likely, there will be a Democratic president after the 2008 elections.  They will be the ones who determine whether and how to fix the PCAOB should the DC Circuit agree with Plaintiffs. 

And fix it they will.  The era of deregulation has come to an end.  See Obama, McCain Likely to Step Up Government Role in U.S. Economy.  Accounting firms require some kind of regulatory oversight. 

So what is the most likely fix?  Not a traditional self regulatory organization, with the governance structure determined by the members.  Possibly accounting oversight could become a task of the SEC.  Counsel for Plaintiffs noted at oral argument that Congress could have avoided any constitutional challenges by transforming the PCAOB into a "traditional independent regulatory agency." 

That is the most likely answer.  The members of the board could be made subject to presidential appointment and removal only for cause.  The President would have little actual control over the activities of the agency but it would pass constitutional muster. 

Would the change in status make a difference?  Board salaries would certainly be lower, potentially impairing the quality of those appointed.  An independent agency would likely be less responsive to the private sector and would have the attendant problems associated with a traditional bureaucracy.  There would be no one to act as a check on the activities.  Would an independent agency have succumbed to the pressure from the SEC and revisited its interpretation of Section 404(b) under SOX? 

If the DC Circuit agrees with plaintiffs in this case (and it should not), the case may well take the place of Business Roundable v. SEC as the most notable Phyrric victory in the realm of securities regulation.  Mostly, though, it will severely damage efforts to link the regulation of securities activities to the private sector.   

We have posted on the DU Corporate Governance web site most if not all of the important documents on the case, including the assorted amicus filed in the appellate case.

Free Enterprise Fund v. PCAOB: Regulation, the Free Market, and the Constitution (The Independence of the SEC)(Part 11)

An interesting little aside concerns the independence of the SEC.  Through out the case, it has been assumed that the President may only remove commissioners for cause.  But is this true?

The Commission was created in the Securities Exchange Act of 1934, replacing the Federal Trade Commission as the oversight body for the securities markets. The Exchange Act provides each Commissioner with a term of years but does not explicitly limit the President's authority to remove to cause.  The sin qua non of an independent agency is congressional restrictions on the President's right to remove those at the head.  Section 4 of the Exchange Act provides:

• (a) Establishment; members; term of office. There is hereby established a Securities and Exchange Commission (hereinafter referred to as the "Commission") to be composed of five commissioners to be appointed by the President by and with the advice and consent of the Senate. Not more than three of such commissioners shall be members of the same political party, and in making appointments members of different political parties shall be appointed alternately as nearly as may be practicable. No commissioner shall engage in any other business, vocation, or employment than that of serving as commissioner, nor shall any commissioner participate, directly or indirectly, in any stock-market operations or transactions of a character subject to regulation by the Commission pursuant to this title. Each commissioner shall hold office for a term of five years and until his successor is appointed and has qualified, except that he shall not so continue to serve beyond the expiration of the next session of Congress subsequent to the expiration of said fixed term of office, and except (1) any commissioner appointed to fill a vacancy occurring prior to the expiration of the term for which his predecessor was appointed shall be appointed for the remainder of such term, and (2) the terms of office of the commissioners first taking office after the enactment of this title [enacted June 6, 1934] shall expire as designated by the President at the time of nomination, one at the end of one year, one at the end of two years, one at the end of three years, one at the end of four years, and one at the end of five years, after the date of the enactment of this title [enacted June 6, 1934].

The provision also originally provided that the commissioners "shall receive a salary of $10,000 a year."  See Conference Report, HR 1838, 73rd Cong., 2d Sess., at 5 (May 31, 1934). 

While the provision provides for a term of years, it is silent with respect to the ability of the President to remove a commissioner for cause.  This could mean that the President has no authority to remove a commissioner of the SEC.  To the extent true, there would be an argument that the removal authority (or lack thereof) is unconstitutional.  The case for an executive branch employee not subject to any ability to be removed (even for cause) would have a greater risk of interfering with the President's ability to carry out his or her executive duties and be unconstitutional.  If that were the case, commissioners of the SEC would be subject to removal at will and the SEC would not be an independent agency. 

The conventional wisdom is that commissioners of the SEC can only be removed for cause.  The legislative history says nothing about this but it does make a number of references to the need for an independent securities commission.  The reference, however, probably means independence from the Federal Trade Commission, the agency originally assigned the task of overseeing the securities laws in the Securities Act of 1933.  It came up in the discussion about whether enforcement of the securities laws should be in the FTC or in a separate, indepenendent agency.  So the language does not provide authority for the proposition that commissioners of the SEC can only be removed for cause. 

The omission of any "for cause" provision is particularly noticeable since the enabling act for the FTC, the alternative body considered for supervision of the securities laws, did explicitly restrict the President's ability to remove commissioners for cause.  See 15 USCS § 41 ("Any commissioner may be removed by the President for inefficiency, neglect of duty, or malfeasance in office.").  On the other hand, Congress the same year created the Federal Communications Commission and likewise did not include a "for cause" removal limitation.  See 47 USCS § 154. 

A few cases have paid lip service to the SEC's independent status and acknowledged that the President has the authority to remove for cause but without much analysis.  See SEC v. Blinder, Robinson & Co., 855 F.2d 677, 681 (10th Cir. 1988) ("The Act does not expressly give to the President the power to remove a commissioner. However, for the purposes of this case, we accept appellants' assertions in their brief, that it is commonly understood that the President may remove a commissioner only for "inefficiency, neglect of duty or malfeasance in office.").  See also MFS Sec. Corp. v. SEC, 380 F.3d 611, 619 (2d Cir. 2004) ("And although the Chairman of the Commission is the most powerful of the five Commissioners owing to his or her additional executive powers within the agency, the power to remove Commissioners belongs to the President, and even that is 'commonly understood' to be limited to removal for 'inefficiency, neglect of duty or malfeasance in office.'").

The DC Circuit in FEF v. PCAOB can take for granted the independent status of the SEC.  Certainly that is the common wisdom.  The statutory basis, however, is surprisingly weak.