Validity of Public Company Accounting Oversight Board Called into Question

December 2009

On December 7, the United States Supreme Court heard oral arguments in a case that called into question the validity of the Public Company Accounting Oversight Board (PCOAB), where the ultimate decision could have far-reaching consequences for some of the reforms enacted pursuant to the Sarbanes-Oxley Act of 2002. The case, Free Enterprise Fund v. Public Company Accounting Oversight Board, Docket No. 08-861, raises a number of questions about the constitutionality of the PCOAB.

Prior to the establishment of the PCAOB, public accounting firms were primarily self-regulated. The PCAOB was created pursuant to the Sarbanes-Oxley Act to provide stronger oversight to public accounting firms, to combat a perceived weakness in the self-regulatory framework that led to cases involving significant financial fraud such as Enron and World Com. The PCAOB is a private organization that establishes accounting standards, takes enforcement actions, and registers public accounting firms to work on public companies. In general, an accounting firm cannot perform any audit work for a public company without being registered with the PCAOB. The PCAOB is funded through fees imposed on public companies (based on their size), and sets its own budget and salaries. The United States Securities and Exchange Commission (SEC) appoints the chair and four directors of the PCAOB, and directors may only be removed with “cause."

The case was brought before the Supreme Court by a group of plaintiffs who argued that the PCAOB violates the separation of powers clause of the United States Constitution, on the grounds that it is an “executive branch” agency over which the President does not have direct control. The Obama administration and the PCAOB argued that the board is constitutional, as the President can exert significant control through his control of the SEC. During oral arguments, several of the Justices questioned exactly how much control the President could directly exert, noting in particular that the salaries of the chair and the other PCAOB board members ($672,676 and $546,891, respectively) are significantly higher than the salaries of the President ($400,000), members of Congress ($174,000) and SEC Chair Mary Schapiro ($162,900), and that none of the President, Congress or the SEC have the authority to directly lower the salaries of the PCAOB board members.

This case is important because of the potential for changes to the broader Sarbanes-Oxley framework if the PCAOB is determined to be unconstitutional. In that event, Congress would need to reestablish the PCAOB, and a number of other provisions of Sarbanes-Oxley may be subject to revision as part of that process. In particular, Congress would likely consider removing the CEO and CFO certification requirements in Sarbanes-Oxley as well as codifying an exemption for smaller filers from the external certification requirements for internal controls contained in Section 404b of Sarbanes-Oxley (an exemption which to date has taken the form of continued extensions from the SEC of the date on which smaller filers must comply). Legislation to this effect has already been approved by the House Financial Services Committee and its passage (or legislation with similar effect) would likely be hastened if it were necessary to rewrite provisions of Sarbanes-Oxley to deal with the PCAOB issue.

A decision on the case is expected in spring, 2010.

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