• Defenders of the law have often made inconsistent arguments. So, sadly, does the appeals court in its divided ruling in Free Enterprise Fund v. PCAOB.

    Defenders claim that the PCAOB is just too important to be struck down over constitutional “technicalities,” and that its function is so important and central to achieving Sarbanes-Oxley’s goals that it must be insulated from political interference (like presidential supervision and control), through statutory provisions declaring it to be an independent, non-profit entity.

    But they simultaneously claim that its members are so unimportant that they need not be picked by the President, contrary to the language of the Constitution’s Appointments Clause, which expressly requires that important government officials be picked by the President with the advice and consent of the Senate.

    The PCAOB is enormously important: The red tape generated by the board has cost the stock market over $1 trillion (according to a University of Rochester study), and annually imposes compliance costs of over $35 billion, while providing only illusory benefits for investors (Countrywide Financial complied with PCAOB rules to the letter, as a way of diverting attention from its risky subprime mortgage lending), and driving businesses and high-tech jobs overseas (the number of U.S. IPOs has shriveled in both absolute and relative terms since the PCAOB was set up).

    Defenders of the PCAOB agree that it is of crucial importance, although for very different reasons: its defenders say it is the “beating heart” and centerpiece of the Sarbanes-Oxley law, and is necessary to restore investor confidence in capital markets.

    But rather than being picked by the President with Senate approval, the way important government officials are supposed to be, PCAOB members are picked by SEC Commissioners as a group (which led to a disorganized selection process for the first PCAOB members, as the GAO has noted).

    The constitutional challenge argues that violates the Appointments Clause of the Constitution, which requires that important government officials be picked by the President, and that lesser government officials be picked either by the President or by the “Head of a Department.”

    The challenge also argued that the PCAOB members are so unaccountable to the president, who can’t remove them (the SEC Commissioners collectively can, but only for “willful” misconduct), that it violates separation of powers.

    In order to reject the constitutional challenges, the court’s majority had to rely on inconsistent reasoning. First, it claimed that the SEC’s Chairman is NOT the SEC’s head, but rather “simply one” of “several commissioners,” making the SEC Commissioners collectively the head of the SEC. See Opinion, at pg. 20 (“The [SEC’s] Chairman . . . is simply one Commissioner”); Opinion, pg. 21 (“The commission” is a body “whose ‘Head’ consists of the several commissioners”). Only by doing that could it rule that the SEC Commissioners collectively are the “Head” of a department and thus are permitted by the Appointments Clause to make appointments. (Never mind that the Chairman has been described by the SEC itself as its “chief executive” and “head”).

    Then, just a few pages later, it suddenly suggested just the opposite: that the SEC’s chairman was, after all, the SEC’s head. Confronted with the argument that the PCAOB is not accountable to the President through his appointees, such as the SEC’s chairman (who, unlike other SEC commissioners, serves at the president’s pleasure), the court stated that the President does have indirect influence over the PCAOB through the SEC, because the president picks the SEC Chairman, whom the court claimed “dominates commission policymaking.” See Opinion, Pg. 24. But if the Chairman so “dominates commission policymaking,” that is because he is the SEC’s actual “head” (its “top executive,” as the SEC describes him), not a mere figurehead.

    Is it too much to ask that courts at least use consistent reasoning? Especially in an important case like this, which Judge Kavanaugh noted is “the most important separation-of-powers case regarding the President’s appointment and removal powers to reach the courts in the last 20 years.”

    (The D.C. Circuit’s suggestion that the President can somehow control the PCAOB through the SEC is fundamentally at odds with the purpose of independent agencies like the SEC, and with the Supreme Court’s decision in Humphreys Executor, which was based on the recognition that independent agencies like the SEC and FTC are constitutional precisely because of the independent, sometimes quasi-judicial, nature of the functions that they perform).

    By the way, although Sarbanes-Oxley declares the PCAOB to be nominally private, as a non-profit corporation, it is considered a government agency for purposes of the Constitution. The Supreme Court’s 8-to-1 decision in the Lebron case declared that nominally private entities are in fact legally government agencies subject to the Constitution (even if they are declared by Congress to be private, the way Amtrak and the PCAOB are), when they exhibit factors like being set up by Congress, and enforcing federal laws.

    The PCAOB’s governmental nature is quite unlike other entities that the SEC has some oversight over, like the New York Stock Exchange, the classic SRO, whose venerable private history and origins stretching back to the early years of the Republic make clear that it is not a government agency under the Supreme Court’s Lebron decision, unlike the PCAOB. The ultimate outcome of Free Enterprise Fund v. Public Company Accounting Oversight Board thus does not implicate their functioning.

  • Many lawyers and legal scholars, like corporate-law expert Stephen Bainbridge and securities-regulation expert Donna Nagy, have questioned the constitutionality of the board (PCAOB) set up by Sarbanes-Oxley. See, e.g., Donna M. Nagy, “Playing Peekaboo with Constitutional Law: The PCAOB and Its Public Private Status,” 80 Notre Dame L. Rev. 975(2005).

    The divided court ruling rejecting the constitutional challenge to the PCAOB is not only internally inconsistent (as I have explained above), but also rests on factual premises conceded to be false by a Senator who voted to create the PCAOB.

    The 2-to-1 decision by the D.C. Circuit claimed, over a strong dissent by Judge Kavanaugh, that PCAOB members really weren’t powerful enough, or independent enough, to be “principal officers” who needed to be appointed by the President with the advice and consent of the Senate, as the text of the Constitution’s Appointments Clause explicitly mandates.

    But the very legislators who voted to create the PCAOB recognized differently. For example, a Senator who voted to pass Sarbanes-Oxley said that the law gave the PCAOB “massive power,” “unchecked power by design.”