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.