High Court Might Have to Rein In Unique Oversight Board

The Public Company Accounting Oversight Board is a legislatively created platypus. In many respects, it looks and acts like a governmental agency. It registers public accounting firms, establishes standards, conducts inspections, adopts rules and imposes sanctions. Yet it is a private nonprofit corporation. In other respects, it resembles a corporation. It is governed by a board and has adopted bylaws. Yet its board members are not elected by members or even self-perpetuating as are many nonprofit boards of directors. Thus, the oversight board hangs in a unique middle space between federal agency and private corporation. Not surprisingly, therefore, its constitutionality has been challenged. Now, the U.S. Supreme Court will determine whether the board can survive as established by Congress.

Congress created the board nearly seven years ago as part of the Sarbanes Oxley Act of 2002. That act was Congress' response to the notorious collapses of Enron, Worldcom and other major public companies amidst allegations of accounting improprieties. Congress decided that something new was required. Public accounting firms that had historically been licensed and regulated by the states would henceforth be subject to federal registration if they issued audit reports for public companies. Moreover, these registered accounting firms would be subject to routine inspection and federal auditing and ethics standards. If registered accounting firms did not measure up, they would be subject to federal sanctions. Finally, registered accounting firms would pay for this new regulatory scheme through fees and annual assessments.

Although federalization of regulation of the accounting profession was new, the substantive elements of the program were not unique. There was nothing especially novel about a regulatory scheme that imposed standards and required registration and inspection. But this new regulatory scheme was entirely unprecedented because Congress vested the oversight of the program not in a federal agency but in a nonprofit entity that was at best only derivatively accountable to the president. Indeed, Sen. Paul Sarbanes emphasized this very point, saying, "We need a truly independent oversight body . . ."

In 2006, a nonprofit public interest organization, the Free Enterprise Fund, and one of its members filed a complaint alleging that the Public Company Accounting Oversight Board was unconstitutional. The district court granted summary judgment for the board and the fund appealed to the U.S. Court of Appeals for the District of Columbia Circuit.

On appeal, the fund argued that the board encroaches on the president's appointment power set forth in Article II, Section 2, clause 2 of the U.S. Constitution. That clause, called the Appointments Clause, grants the president the power, with the advice and consent of the Senate, to appoint, among others, "Officers of the United States." But the Appointments Clause provides that Congress may by law vest the appointment of "such inferior Officers, as they think proper, in the President alone, or in the Courts of Law, or in the Heads of Departments."

When Congress established the board, it did not treat the members of its governing board as officers to be appointed by the president with the advice and consent of the Senate. Nor did Congress provide that the board's members be appointed by the president alone. Rather, Congress provided that the Securities and Exchange Commission would appoint members after consultation with the chairman of the Board of Governors of the Federal Reserve System and the secretary of the Treasury. Interestingly, the commission was not required to consult with the president.

The Court of Appeals held 2-1 that there was no violation of Appointments Clause. Free Enterprise Fund v. Public Company Accounting Oversight Board, 537 F.3d 667 (D.C. Cir. 2008). The key to the majority's analysis was its finding that the board's members are inferior officers because the Appointments Claus requires that superior officers be appointed by the president with the advice and consent of the Senate. The majority rested its conclusion on its view that the board is subject to comprehensive control by the SEC.

In a lengthy dissent, Judge Brett Kavanaugh concluded that members are truly superior officers. He pointed out that they are not removable at will. The SEC can only remove members for cause. This provides a measure of substantive independence that makes the members superior officers. Kavanaugh also argued that the SEC did not have the power "to prevent and affirmatively command, and to manage the ongoing conduct of, Board inspections, investigations, and enforcement actions." Interestingly, neither the majority nor Kavanaugh believed Congress when it said: "No member or person employed by, or agent for, the Board shall be deemed to be an officer or employee of or agent for the Federal Government by reason of such service" (emphasis added).

The Free Enterprise Fund also challenged the board on the grounds that it violates the separation of powers principle. In rejecting this challenge, the majority noted that the Supreme Court had recognized that independent agencies are constitutionally permissible in Humphrey's Executor v. United States, 295 U.S. 602 (1935). That case involved President Franklin Roosevelt's attempt to fire William Humphrey, an appointee of President Hoover to the Federal Trade Commission. Under the Federal Trade Commission Act, commissioners were appointed by the president for fixed terms with the advice and consent of the Senate. Once appointed, a president could remove commissioners only for inefficiency, neglect of duty or malfeasance in office. The Supreme Court sided with Humphrey. In the wake of this decision, there are now many independent federal agencies, including the SEC.

Kavanaugh, however, was not persuaded that Humphrey's Executor required upholding the board. He emphasized that the board is quite unlike the Federal Trade Commission because its members cannot be removed directly by the president. Rather, they are removable by the SEC and then only for cause. Because the SEC's commissioners are removable by the president only for cause, the president is two levels away from for-cause removal of Public Company Accounting Oversight Board members. In Kavanaugh's view, it is this layering of for-cause removal power that makes the board unique and distinguishes it from independent agencies like the FTC.

The Supreme Court will now decide who is right. It will do so in the shadow of a new financial crisis, albeit a crisis born of more diffuse causes and less directly tied to accounting chicanery than was the case in 2002. The Supreme Court should, of course, ignore this background. It should also ignore any arguments about whether the board has been doing a good or bad job. These matters are irrelevant. The Supreme Court should decide the case on its constitutional merits.

If the Supreme Court finds that the board is unconstitutional it will not mean that Congress lacks the authority to regulate auditors of publicly traded companies. Congress could vest this authority in the SEC or another agency or it could create a new federal agency whose leadership is appointed by the president and subject to removal by the president.

The Public Company Accounting Oversight Board is a unique beast. Like the platypus, which shares the traits of both mammal and bird, the board shares the traits of both a federal agency and a private entity. To allow Congress to create hybrid agencies is to allow the creation of new branches of government composed of super-independent agencies that have no direct accountability to the president either in appointments or removal. This violates Article II of the Constitution, which vests in the president the sole power and responsibility to "take care that the law be faithfully executed." If the president can neither directly appoint nor directly remove the board members, he cannot fulfill this responsibility.

Keith Paul Bishop previously served as California's commissioner of corporations and interim savings and loan commissioner. He is a partner at Allen Matkins Leck Gamble Mallory & Natsis in Irvine and an adjunct professor of law at Chapman University School of Law.