Public Company Accounting Oversight Board

False Claims by Government in Supreme Court Case: PCAOB Agency Is More Powerful and Independent Than Government Claims

by Hans Bader on December 6, 2009 · 3 comments

in Legal, Politics as Usual, Regulation

The members of the Public Company Accounting Oversight Board (PCAOB), an agency being challenged in the Supreme Court on December 7, aren’t appointed by the president, nor can he remove them. The General Accounting Office describes the PCAOB as “an independent board with sweeping powers and authority;” its rules and red tape cost the economy billions of dollars every year (with an long-term cost of perhaps $1 trillion).

Yet the government suggests in its brief that the president has “fully effective control” over the PCAOB (see pg. 46 of that brief). That’s not the only peculiar claim made in the PCAOB’s defense.

The case raises the issue of whether members of an agency — the PCAOB — picked by the members of yet another independent agency — the five Commissioners of the Securities and Exchange Commission (SEC) acting as a group — are, in light of their broad policy making role, actually “principal officers” who thus should have been picked instead by the president under the Constitution’s Appointments Clause. Alternatively, assuming that PCAOB members are mere “inferior” officers, the case raises the issue of whether they should have been picked, as the Appointments Clause requires for inferior officers, by the “Head” of a “Department,” rather than the SEC Commissioners acting collectively (the SEC has a Chairman who manages it and supervises its staff).

Government lawyers argue that the PCAOB is so controlled by the SEC that its members are mere inferior officers, and claim that the SEC is headed by all its Commissioners, not its Chairman. But as Jonathan Moore has noted, a long-time SEC commissioner debunked these claims on December 3. Former SEC Commissioner Paul Atkins took the exact opposite view, in a panel discussion at the American Enterprise Institute, which one can view and listen to here (Atkins was the fifth speaker; I also spoke at the event, and Jonathan Moore, who was in the audience, questioned the panel).

Atkins spoke at length about the PCAOB and how difficult it was for the SEC to influence the PCAOB. He noted that the PCAOB had enough autonomy to frustrate the SEC’s attempts at oversight. When the SEC sought a business plan from the PCAOB, the PCAOB Chairman said that “the statute was his business plan” and more or less failed to comply. It took five years to get something akin to a business plan from the PCAOB. Atkins said that PCAOB’s “Audit Standard 2” “has a very checkered history” and illustrated the “limits” of SEC oversight. The 400 pages of requirements from Auditing Standard No. 2 made compliance with Sarbanes-Oxley “very difficult” and “very costly.”

Atkins noted that “All five commissioners” were in favor of “radical” changes to it, yet it took years for them to obtain merely “some” changes to that audit standard, owing to the need for consensus and PCAOB foot dragging. He recounted how the PCAOB adopts “staff-driven” rules through “informal rulemaking” that apply without being approved by the SEC, regardless of Sarbanes-Oxley’s formal approval process for rules. Atkins says, for example, that its guidance regarding “stock options” was “not subject to any rule at all,” despite functioning in practice as a rule. While the SEC has to approve formal rules, the PCAOB functions heavily through informal rules never approved by the SEC. He said that “Peekaboo does have real power,” “investigative power,” and “prosecutorial power.” Although the SEC theoretically reviews the PCAOB’s budget, Atkins noted that “staff at Peekaboo were not telling the truth” about the PCAOB’s budget system to the SEC, making evaluation of its budget and spending difficult. He noted that on the SEC’s website, there is video footage of his concerns over this at the last budget meeting. He noted that because of the PCAOB’s separate status and the SEC’s lack of control over PCAOB staff, the “SEC found it didn’t really have the authority” to control the PCAOB’s budget that it supposedly did.

Atkins noted that the SEC’s “power is not plenary” over the PCAOB, that it was difficult to get a group consensus focused on oversight over the PCAOB, and that oversight of the PCAOB was “like pushing on a string.” He said that the current set-up under Sarbanes-Oxley is a “very difficult way for the SEC to oversee a separate board.” He cited “flawed implementation of [SOX Section] 404” from 2002 to 2006 as an example, and noted the “incredible amount of attention diverted” to accounting issues that were not important as a result of the PCAOB’s internal-controls rules.

He addressed the question of whether the SEC’s chairman is its head for appointments clause purposes. He said that the Founders realized the “committee structure” or the “committee system was not a very effective decision making type of body” for things like appointments, and cited the 1950 Reorganization Plan 10 that vested “authority over the budget” and “HR decisions” in the SEC’s chairman. Although he noted that “consensus” is desired for key posts like the General Counsel, when push comes to shove, “in reality, he [the Chairman] can still appoint who he wants.” He said that the idea that PCAOB members – or even SEC members – were really accountable to the president was silly, and that the SEC’s own history “illustrates how difficult it is for the President to assert authority” over the SEC, much less the PCAOB.

Atkins’ observations debunk the government’s suggestion that the president has “fully effective control” over the SEC – and the lower court ruling upholding the PCAOB, which claimed that the SEC was not headed by its Chairman, but by SEC Commissioners as a group – a claim based on that court’s inconsistent reasoning. Law professor Donna Nagy similarly debunks claims that the PCAOB is “heavily controlled” by the SEC in a forthcoming article in the Pittsburgh Law Review, noting that PCAOB members are “principal officers” “acting with significant discretion and autonomy outside the SEC’s control” who constitutionally must be appointed by the president — not, as is currently the case, by the SEC Commissioners as a group.

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).

Courts sometimes take judicial notice of such statements. 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); id. at 730, n.14 (plurality) (citing news articles about website’s earlier content).

Reps. Maloney and Adler push true bipartisan stimulus — Sarbanes-Oxley relief

by John Berlau on October 28, 2009 · 2 comments

in Deregulate to Stimulate, Economy, Nanny State, Personal Liberty

After months of talk about solutions that would rev up job growth and the economy, today the House Financial Service Committee may finally adopt a true bipartisan stimulus. Led by Democratic Reps. Carolyn Maloney of New York and John Adler of New Jersey, two amendments will likely be introduced to the Investor Protection Act that would truly stimulate the economy by partially liberating investors, entrepreneurs and innovators from the shackles of a seven-year-old “investor protection” law that has added billions in costs while providing little if any benefits to investors and doing nothing to prevent the recent financial crisis: the Sarbanes-Oxley Act of 2002.

Maloney, whose most recent legislative accomplishment was the Credit Card Holders Bill of Rights that was signed by President Obama in May and hailed by liberal groups, has teamed with conservative Rep. Scott Garrett, R-N.J., to introduce an amendment to extend the exemption for smaller public companies – those with less than a $75 million market cap – from the costly audit of internal controls from the law’s Section 404 to at least June 2011 and until the Securities and Exchange Commission and Government Accountability Office each perform a study. This is important because the current exemption expires next June, and SEC Chairman Mary Schapiro recently said that there will absolutely, positively be no further extension, despite the limited research on the effects of Sarbox on the very smallest companies and the extensive research showing often devastating burdens on midsize and even large ones.

Rep. Adler goes one further. His amendment would exempt small and midsize companies – those with market caps of less than $700 million, the mark above which the SEC classifies companies as “large accelerated filers” – from Sarbox Section 404 until the SEC promulgates “regulations that take into consideration the different characteristics and limitations of various sized companies,” according to a “Dear Colleague” from Adler. In the letter, obtained by OpenMarket but not yet posted on the web, Adler states: “My amendment will increase America’s competitiveness within the global economy and create jobs here at home. When a company goes public, investors invest capital, the company expands and jobs are created.”

Indeed, new research from the University of Pittsburgh’s Kenneth Lehn and others demonstrates in detail the damage Sarbox is doing to job growth by showing how its costs reduce business spending on research and development and other precursors to job growth. Rammed through Congress in 2002 in the rush to “do something” after the Enron and WorldCom accounting scandals, Sarbox has had many perverse effects recognized by Republicans and Democrats. In 2006, now-Speaker Nancy Pelosi decried the law’s “unintended consequences” for entrepreneurs.

University of Rochester researcher Ivy Zhang has found that Sarbox has racked up $1.4 trillion in direct and indirect costs to the U.S. economy, with no quantifiable economic benefits. By far, the biggest cost is from Section 404’s internal control mandates, which the American Electronics Association calculated as costing U.S. public companies $35 billion a year, and as much as quadrupled an individual company’s auditing and compliance costs, according to the Foley & Lardner law and consulting firm.  This section’s price tag is largely because the Public Company Accounting Oversight Board, the powerful yet unaccountable regulator created by Sarbox (and whose constitutionality is being challenged in a case before Supreme Court this term in which CEI attorneys are serving as co-counsel), required full-blown audits for internal controls as well as a company’s number. That is what turned Sarbox into what has been called “The Accountants Full Employment Act,” in which accountants are reviewing “internal controls” such as possession of office key, the number of letters in an employee password and other items of little relevance to the average shareholder.

Tech journalist John Battelle reported that Sarbox was even frustrating for a company as big as Google, because of the extensive red tape that went along with documenting innovative technology. According to Battelle, becoming Sarbox compliant when Google went public in 2004 was “no small feat,” because “the law requires an audit trail of every third party transaction, and Google has millions of them a week in its [search] engine.” And keep in mind that Google already had a market cap of more than $1 billion when it went public in 2004. So the smaller innovative companies with the potential to be the Googles and Microsofts of tomorrow might not be able to get over this Sarbox hurdle and raise the capital they need by going public.

And new, groundbreaking research shows that Sarbanes-Oxley hits cutting edge software and biotechnology firms especially hard, reducing the amounts they spend on research and development that could lead to new fields that create new job.  A 2008 paper from University of Pittsburgh economist Kenneth Lehn that was selected for a conference of the Federal Reserve Bank of Atlanta finds that “greater evaluation and testing of

internal controls [is] required for firms with activities involving specialized knowledge.” And Lehn’s study includes data from 2007, after the SEC and PCAOB supposed “tailored” Sarbox to make compliance easier for smaller companies.

A letter from The Biotechnology Industry Organization that Lehn cites states that biotech firms “are directing precious resources from core research and development of new therapies for patients” to costly Sarbox compliance.

And ironically, the bells and whistles of Sarbanes-Oxley’s “internal controls” may ironically be taking the core focus off of rooting out fraud. In 2007 Countrywide Financial Corp. was praised for its Sarbox controls by the Institute of Internal Auditors. Two years and many scandals later, its former executives have been charged with securities fraud. And certainly, overall transparency doesn’t increase when companies go private or delay going public, as many have chosen to do because of Sarbox’s costs.

In addition to the valuable Adler and Maloney-Garrett measures, Rep. Michelle Bachmann, R-Minn., will likely introduce a worthy amendment to keep the underlying Investor Protection Act from expanding Sarbox and the PCAOB’s reach to include non-public broker dealers (an incredible power grab that jettisons the whole justification for Sarbox protection of average investors – they might have to change the name to the NCAOB – Nonpublic Company Accounting Oversight Board) until the Supreme Court rules on the entity’s constitutionality.

Her amendment will  also likely propose transferring the responsibility of appointing powerful members of the PCAOB from the SEC to the President, with Senate confirmation. This is what CEI and other attorneys argue in the court case is constitutionally required, since PCAOB members are important “principal officers” with authority to make rules that have such a large impact on the U.S. economy. The Bachmann amendment is also bipartisan in spirit, as it gives more power to President Obama, but also institutes the constitutional accountability needed for this powerful agency.

Law Professors Urge Supreme Court to Review Challenge to Powerful Agency, in Free Enterprise Fund v. Public Company Accounting Oversight Board

by Hans Bader on May 13, 2009

in Deregulate to Stimulate, Economy, Legal, Personal Liberty, Precaution & Risk

Tomorrow, the Supreme Court will weigh whether to decide what a federal judge called the “the most important separation-of-powers case regarding the President’s appointment and removal powers to reach the courts in the last 20 years.” Law professors Kenneth Starr and Viet Dinh, who worked on the case, have an editorial in today’s Wall Street Journal urging the Supreme Court to hear the case, which challenges a powerful, and largely unaccountable, federal agency called the Public Company Accounting Oversight Board (PCAOB). As they point out, in creating the PCAOB, “Congress created a striking Constitutional anomaly – a powerful executive branch agency with a structure that gives the President almost no say over its policies.”

Last year, a divided D.C. Circuit Court of Appeals voted 2-to-1 to uphold a provision of the Sarbanes-Oxley Act, over a strong dissent by Judge Kavanaugh, in the case of Free Enterprise Fund v. Public Company Accounting Oversight Board. That ruling deserves Supreme Court review both because the case is exceedingly important, and because the ruling rests on reasoning that is disturbingly inconsistent.

The case challenges the PCAOB, the regulatory board set up by the 2002 Sarbanes-Oxley Act, as a violation of the Constitution’s Appointments Clause and separation of powers. The PCAOB is enormously important: As Starr and Dinh note, “A Brookings-American Enterprise Institute study found that all of Sarbanes-Oxley’s provisions – mostly enforced by the PCAOB – have cost the U.S. economy more than $1 trillion in direct and indirect costs.” Moreover, the PCAOB’s red tape imposes annual compliance costs of over $35 billion, while providing only illusory benefits for investors, and driving businesses overseas. The PCAOB enjoys “massive power,” “unchecked power by design,” according to a Senator who voted to create it.

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 Starr and Dinh note, “The PCAOB’s lack of an accountable structure has likely contributed to what members of both parties see as its policy failures, such as its failure to stem inadequate disclosures by “firms reporting subprime securities.”

The lawsuit says that violates the Appointments Clause of the Constitution, which requires that government officials be picked by the President or (for minor officials) by the “Head of a Department.” The lawsuit 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, who “dominates commission policymaking.” See Opinion, Pg. 24. (It said that “by appointment of the Commission chairman, who serves at the pleasure of the President and often ‘dominate[s] commission policymaking,’ the President can influence Commission policy and control who directs ‘the administrative side of commission business, select[s] most staff, set[s] budgetary policy, and as a consequence command[s] staff loyalties.’” 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 concedes), not a mere figurehead.

Is it too much to ask that courts not rely on inconsistent reasoning? Especially in a 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.”