Supreme Court Sarbanes-Oxley Decision: You Can't Keep An Executive Branch Board Two Layers from the President


In a decision today, the Supreme Court declared the legal structure of the Sarbanes-Oxley enforcement body the Public Company Accounting Oversight Board (PCAOB) unconstitutional on separation of powers grounds, because its members are two layers away from direct presidential authority.

The president, you see, can order around or remove members of the Securities and Exchange Commission (SEC) (though only for good cause, though the dissent in the case argues that might not be factually true). And members of the SEC can order around and remove members of PCAOB, also only for good cause.

The accounting firm Beckstead and Watts, feeling bedeviled by picayune commands regarding their corporate accounting issued by PCAOB, sued (with the help of free market advocacy group the Free Enterprise Fund) on the grounds that Congress giving enforcement powers to a body under no direct control of the president did not fit into the constitutional structure of the legislative-executive-judicial separation of powers. (They also challenged PCAOB on other grounds, though those other grounds went nowhere.)

Today they won the case of Free Enterprise Fund v. Public Company Accounting Oversight Board on the separation of powers argument.

Here's the heart of why the Supreme Court believes that PCAOB was one layer too many away from Barack Obama (and future holders of his office):

such multilevel protection from removal is contrary to Article II's vesting of the executive power in the President. The President cannot "take Care that the Laws be faithfully executed" if he cannot oversee the faithfulness of the officers who execute them. Here the President cannot remove an officer who enjoys more than one level of good-cause protection, even if the President determines that the officer is neglecting his duties or discharging them improperly. That judgment is instead committed to another officer, who may or may not agree with the President's determination, and whom the President cannot remove simply because that officer disagrees with him. This contravenes the President's "constitutional obligation to ensure the faithful execution of the laws."

Another bit from the majority decision, written by Samuel Alito Chief Justice John Roberts that I found delightful (addressing the dissent's argument that, more or less, complicated government requires a complicated set of enforcement agencies and structures and technical experts that can't be shoved into the tight structure we were left with by the Constitution):

One can have a government that functions without being ruled by functionaries, and a government that benefits from expertise without being ruled by experts. Our Constitution was adopted to enable the people to govern themselves, through their elected leaders. The growth of the Executive Branch, which now wields vast power and touches almost every aspect of daily life, heightens the concern that it may slip from the Executive's control, and thus from that of the people. This concern is largely absent from the dissent's paean to the administrative state.

The upshot of the decision is that now PCAOB members can be fired by the SEC at will, leaving only one layer of "fired only for cause" between them and the president. It does not mean that SarbOx has been "overturned." As the decision says:

petitioners are not entitled to broad injunctive relief against the Board's continued operations. But they are entitled to declaratory relief sufficient to ensure that the reporting requirements and auditing standards to which they are subject will be enforced only by a constitutional agency accountable to the Executive.

Reaction from the free-market think tank Competitive Enterprise Institute, employees of which were co-counsels to the plaintiffs, hitting on some reasons why the business community was pissed about PCAOB:

The board's lack of accountability under the Constitution is reflected in its flawed rules.  For example, the board's "internal control" mandate costs companies $35 billion a year and has auditors going over trivial minutiae such as the possession of office keys and the number of letters in employee passwords. Meanwhile, in the nearly eight years of its existence since Sarbanes-Oxley was passed in 2002, the PCAOB has done little to address auditing rules for off-balance sheet entities that were the core Enron's accounting problems and that flared up again to hide debt at Lehman and other financial firms.

The shortcomings of the PCAOB and Sarbanes-Oxley have been recognized by members of both parties. The House-Senate conference for the pending financial regulation bill agreed to accept a measure permanently exempting smaller public companies from the PCAOB's internal control mandates. 

The PCAOB's mandates and possibly other sections of Sarbanes-Oxley may now be subject to legal challenge. We look forward to working through the courts and/or Congress to correct the flawed rules from an unconstitutional body that have been holding our economy back.

This does not, in and of itself, overturn any specific action of the PCAOB. According to CEI's financial policy director, John Berlau, while past court cases create ambiguity about how automatically the actions of an agency found unconstitutional will be in and of themselves found invalid, today's decision opens up past Sarbanes-Oxley enforcement actions from PCAOB to future court challenges.

The PCAOB, interestingly, is not considered technically a government body by Congress, which created it, although violating its dictates is a federal crime. 

SCOTUSwiki's great summation of the case, its meaning, oral arguments, and history. I wrote in Reason magazine's April 2007 issue about the beginnings of the case.