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By: Michael McCloskey and David Aveni (Foley & Lardner LLP)
On June 28, 2010, the United States Supreme Court decided that the procedure for removing members of the Public Company Accounting Oversight Board (“PCAOB”) was unconstitutional. Instead of dismantling the PCAOB, however, the Court transformed the removal standard from one based on good cause to one in which members of the PCAOB are now removable at will by the Securities and Exchange Commission. With that modification, the Court stated that the PCAOB may continue to function as before, and the Sarbanes-Oxley Act remains “fully operative as a law.”
The PCAOB was created as part of the Sarbanes-Oxley Act of 2002 and has broad authority to regulate accounting firms that participate in audits of public companies. The PCAOB is comprised of five members who are appointed by the Securities and Exchange Commission, and who were removable by the SEC only “for good cause,” and in accordance with specific removal procedures. In Free Enterprise Fund v. PCAOB, the constitutionality of the PCAOB and the removal procedures for its board members was challenged by an accounting firm whose auditing procedures had been criticized by the PCAOB.
The Supreme Court held that the removal procedures were unconstitutional under the separation of powers doctrine. Under the Constitution, the President is tasked with the duty to “take Care that the Laws be faithfully executed,” which has been interpreted to include the duty to remove executive officers from office, if necessary. The Supreme Court had previously upheld the constitutionality of government agencies headed by officers whom the President may remove only for good cause. However, in Free Enterprise Fund, the Court addressed a new twist on this removal for cause procedure which had not been previously considered: namely, whether there may be multiple levels of “good cause” removal limitations between the President and the officer.
The members of the PCAOB could only be removed for good cause by the Securities and Exchange Commission, whose Commissioners themselves may only be removed for good cause by the President. The Court concluded that this “duel for-cause limitation” violates the separation of powers doctrine because “it withdraws from the President any decision on whether that good cause [for removal of a PCAOB member] exists.” That decision instead is made by the SEC Commissioners, who are not under the President’s direct control, since they themselves cannot be removed except for good cause. Thus, if the President disagrees with their decision whether to remove a PCAOB member, the President is unable to act unless the Commissioners’ decision itself is so unreasonable as to constitute good cause for the Commissioners’ removal.
The Court held that the existence of two levels of good cause removal protection between the President and the PCAOB members obstructed the President’s ability to hold his subordinates accountable as required under the Constitution. Striking down the removal provisions, the Court held that going forward, the PCAOB members could be removed by the SEC “at will.”
While striking down the removal procedure, the Court refused to find that this flaw rendered the very existence of the PCAOB invalid. Instead, the Court concluded that the removal provisions are severable from the remainder of the Sarbanes-Oxley Act, leaving the statute otherwise intact and the PCAOB fully functional as before. Thus, by rendering a narrow decision, the Court left in place the corporate business practice reforms adopted through Sarbanes-Oxley in the wake of Enron and other similar accounting scandals.
Severing the removal restrictions, thus sparing the PCAOB, is not likely to have a sweeping impact on the ability of that Board to enforce the Sarbanes-Oxley Act. While the decision may prompt challenges to removal procedures for officers or employees of other federal agencies, the ability of the PCAOB to oversee auditors remains intact.
Provided By:
Foley & Lardner LLP
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