On December 7, the U.S. Supreme Court will hear Free Enterprise Fund v. Public Company Accounting Oversight Board. The case, brought by CEI and Jones Day attorneys on behalf of the Free Enterprise Fund, challenges the constitutionality of the way Public Company Accounting Oversight Board (also known as PCAOB, or not so affectionately as Peekaboo) members are appointed. The PCAOB, which was established by the Sarbanes-Oxley Act of 2002, is an independent governmental agency (according to Sarbanes-Oxley it is a private institution, but even supporters of the Board’s structure admit that it is a governmental body) whose members are selected by the SEC commissioners collectively. The lawyers arguing the case argue that this selection process violates the appointments clause of the Constitution.
The Constitution, in Article 2 sec. 2, establishes that the President “Shall have Power, by and with the Advice and Consent of the Senate to… nominate, and by and with the Advice and Consent of the Senate, shall appoint Ambassadors, other public Ministers and Consuls, Judges of the supreme Court, and all other Officers of the United States, whose Appointments are not herein otherwise provided for, and which shall be established by Law: but the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone, in the Courts of Law, or in the Heads of Departments.”
According to the Constitution, the President is responsible for appointing what has later been defined as “principal officers.” Further, if the officers are deemed to be “inferior officers,” Congress may give appointment power to the President, a judge, or the head of a department. Lawyers for the Free Enterprise Fund charge that regardless of whether the PCAOB members are principal or inferior, the Constitution has been violated. The President does not appoint the board members, and as such, if they are principal officers, the Constitution has been violated. If the board members, however, are inferior officers, they have not been appointed by a head of a department, rather, they have been appointed by the SEC commissioners.
Lawyers defending the constitutionality of the PCAOB have charged that the board members are inferior officers, and that the SEC commissioners collectively are the head of the SEC. Further, they claim that the SEC has complete control over the PCAOB through several powers, including the power to review all PCAOB rules, and approving the PCAOB’s budget. As such, they argue, this direct supervisory authority makes the PCAOB clear inferior officers, and since the President has control over the SEC commissioners, who have control over the PCAOB, the President has “fully effective control” over the PCAOB.
Yesterday, however, at an American Enterprise Institute event titled “Public Company Accounting Oversight Board: A Preview”, former SEC Commissioner (2002-2008) Paul Atkins provided an alternative story of the SEC’s control over the PCAOB, as well as refuting the claim that the SEC commissioners are collectively the head of the SEC.
Atkins noted several areas in which the PCAOB managed to evade SEC controls and operate very independently of the SEC. First, he stated that the PCAOB’s budget was not nearly as under control by the SEC as has been claimed. Atkins stated that the “staff at Peekaboo were not telling the truth” to the SEC about the PCAOB’s budget. His experience at the SEC led him to the conclusion that the SEC “didn’t really have the authority it supposedly did” over the PCAOB’s budget.
At one point, the SEC asked the PCAOB for a business plan regarding their operations. The PCAOB chairman informed the SEC that Sarbanes-Oxley “was his business plan” and for five years the PCAOB evaded the SEC’s demand for a business plan.
After the PCAOB produced their “Audit Standard 2”, “all five” SEC commissioners were in favor of “radical” changes to it, and yet it took the SEC years to even make “some” changes to the auditing standards due in part to PCAOB recalcitrance.
He stated that the PCAOB used “informal rulemaking” to adopt “staff-driven” rules which evaded the need to obtain SEC approval for all rules. As an example, he says that the PCAOB’s rule making regarding stock options was “not subject to any rule at all” despite functioning as a rule.
Atkins directly refuted the claim that the SEC has plenary power over the PCAOB, stating bluntly that the SEC’s “power is not plenary” regarding the PCAOB. He even said that a good analogy for SEC oversight of the PCAOB was that of “pushing on a string”.
Atkins also implied that considering the SEC commissioners as a collective head for the SEC was ignoring the realities of the day-to-day operation of the SEC. He stated that the chairman has considerably more power than the other commissioners. He noted that the 1950 Reorganization Plan 10 gave “authority over the budget” and “HR decisions” to the SEC’s chairman. He did say that consensus among the commissioners is generally important, but said that “in reality, he can still appoint whoever he wants” to critical appointment posts. And yet, this does not apply to the PCAOB, who are appointed collectively by the SEC. Further, Atkins even questioned whether or not the President had direct power over the SEC, a lynchpin of the defenders of the SEC’s argument. He stated that the SEC’s history “illustrates how difficult it is for the President to assert authority” over the SEC, much less the PCAOB.
Atkins’ telling of the SEC and PCAOB’s relationship calls much of the PCAOB’s legal defense into question. If the SEC lacks reliable control over the PCAOB, how can the President have “fully effective control” over the PCAOB? If, one wonders, the SEC chairman is treated as the appointer for other positions within the SEC, which implies that he is the head of the department, why is it that he does not have the power to appoint the PCAOB members? And why is the SEC chairman sufficiently powerful to act as the head in all other appointment cases, but when it comes to the PCAOB he must act as an equal to his fellow commissioners? And further, if the President lacks even control over the SEC, how can he truly have control over the PCAOB members, who are an additional step further down the chain of command?
These are some questions the justices should be asking on December 7.
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Law professor Donna Nagy similarly notes that PCAOB members are "principal officers" who should have been picked by the President, not the SEC, and that the SEC's control over the PCAOB is limited, in a forthcoming law review article in the Pittsburgh Law Review.
The article is entitled, "Is the PCAOB a 'Heavily Controlled Component' of the SEC?: An Essential Question in the Constitutional Controversy."
It is summarized at http://www.newswise.com/articles/view/559223?print-artic...
Also available online is the text of SEC Commissioner Paul Atkins’s earlier 2006 speech noting the SEC’s limited ability to control the PCAOB (such as the PCAOB’s unapproved guidance on subjects like ”options grants” and the PCAOB chair’s view that the PCAOB is more like the SEC’s ”cousin” than its subordinate).
That's available on the SEC's web site. The URL is given in my December 5 commentary about the PCAOB at the Examiner (and there is a link to it in my most December 6 commentary about it at this blog).
A concise explanation of how the PCAOB violates the Constitution’s Appointments Clause, and why that matters, can be found at
http://cei.org/pdf/4873.pdf
The PCAOB’s unconstitutional appointment process has had real world negative consequences.
As two law professors noted in the Wall Street Journal, “The PCAOB’s lack of an accountable structure has likely contributed to what members of both parties see as its policy failures. It did not foresee the disclosure issues for firms reporting subprime securities” that contributed to the financial crisis. Their column is available at:
http://online.wsj.com/article/SB12421692501791267…
Moreover, it created a huge mess when the first slate of PCAOB members was selected. As the GAO noted in a December 2002 report, the PCAOB’s collective appointment process was a fiasco when it was used to select the first PCAOB members, leading to the resignation of the first PCAOB chair after his role in an accounting scandal became known.
The GAO report is available at:
http://www.gao.gov/new.items/d03339.pdf
A court could take judicial notice of Atkins's speeches available on the web sites of the SEC and AEI. See Nebraska v. EPA, 331 F.3d 995, 998 n.3 (D.C. Cir. 2003) (taking judicial notice of statements on web site); Cf. Parents Involved in Community Schools v. Seattle School District No. 1, 551 U.S. 701, 780 n. 30 (2006) (Thomas, J., concurring) (quoting from web site).
CFO.com, the web site of CFO Magazine, similarly noted on December 9 that "former SEC commissioner Paul Atkins has recently disputed that notion" that the PCAOB's actions are all subject to SEC approval, in comments related to the pending case of Free Enterprise Fund v. PCAOB.
See Sarah Johnson, "What Don't You Know About Your Auditor," available at
http://www.cfo.com/blogs/index.cfm/l_detail/14461…
Cf. Parents Involved in Community Schools v. Seattle School District No. 1, 551 U.S. 701, 730 n.14 (plurality) (relying on news articles about relevant comments once found on web site); Nebraska v. EPA, 331 F.3d 995, 998 n.3 (D.C. Cir. 2003) (taking judicial notice of statements on web site).
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