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On February 9, the Competitive Enterprise Institute helped file a lawsuit challenging the constitutionality of the Public Company Accounting Oversight Board (PCAOB), a federal agency created by the Sarbanes-Oxley Act of 2002. The PCAOB enjoys broad power over the auditing and internal financial controls of America’s public companies. Sen. Phil Gramm (R-TX), who voted for its creation, confessed that it would have “massive power, unchecked power, by design” and would “make decisions that affect all accountants and...indirectly every breathing person in the country.” He was right. Now that the agency is operating, its red tape is costing the American economy over $35 billion annually.
Despite its vast powers, the PCAOB is not accountable to our elected representatives. Its members are chosen collectively by the members of the Securites and Exchange Commission (SEC) and cannot be removed except for serious wrongdoing. In our lawsuit, we argue that this violates the Constitution’s Appointments Clause, which requires that powerful officials be selected by the President and confirmed by the Senate.
The PCAOB—known not-so-affectionately in the business community as “peekaboo”—has broad authority to issue rules governing the auditing of all public companies. It supports itself with a tax it levies on all public companies. It also has the power to punish accountants for violating its rules. It can fine an accountant up to $100,000 or an accounting firm up to $2 million for a single inadvertent violation. PCAOB rules have given auditors the power—and duty—to micromanage corporations’ internal financial controls, such as what software a company uses and who has access to employee passwords.
Not only do the five PCAOB members wield broad investigative and rule making powers, they effectively have the power to set their own salaries. The PCAOB’s Chairman was paid a generous $556,000 in 2003, while other members were paid a handsome $452,000.
The Constitution’s Appointments Clause provides that the President “shall nominate, and by and with the Advice and Consent of the Senate, shall appoint” all “Officers of the United States, whose Appointments are not herein provided for...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.” (U.S. Const. Art. II, § 2, clause 2.) Thus, an officer of the United States must either be appointed by the President, or, if the officer is an “inferior officer,” be appointed by either (1) the President, (2) a Court, or (3) a Head of Department.
PCAOB members are clearly “officers” under Supreme Court precedent, since their powers—such as the ability to impose $2 million fines—more than meet the Court’s criteria of “significant authority.” While PCAOB actions are subject to SEC review, the Supreme Court has found that the ability to impose substantial sanctions makes bureaucrats federal officers even if “they lack authority to enter a final decision.” And the PCAOB does have final authority in at least one area: Its decisions on whether or not to investigate an accountant are unrevieweable.
Because the PCAOB’s members are officers, regardless of whether they are considered to be “principal” or “inferior” officers, their manner of appointment violates the Appointments Clause. The Constitution provides that inferior officers can be appointed any of three ways: by either the President, a court, or a Head of Department. Plainly, they are not appointed by the President or a court. Nor are they appointed by a “Head of Department,” since the SEC is not a “department” under Supreme Court precedent, and even if it were, only its Chairman, not its other Commissioners, as its “head,” would have the power to appoint.
The SEC does not meet the legal test for what constitutes a “department” with the power to appoint. As the Supreme Court observed in its 1991 Freytag decision, the “Court for more than a century has held the term ‘Department’ refers only to ‘a part or division of the executive government, as the Department of State, or of the Treasury’ expressly ‘creat[ed]’ and ‘given the name of a department’ by Congress.” Thus, the Court favored “confining the term ‘Heads of Department’ in the Appointments Clause to executive divisions like the Cabinet-level departments,” because “(t)heir heads are subject to the exercise of political oversight and share the President’s accountability to the people.”
Even if the SEC were somehow found to be a “department,” the PCAOB would still violate the Appointments Clause, because it vests the appointment power in the SEC Commissioners collectively, when only the Chairman is the SEC’s head. An entity can only have one head. Moreover, the SEC’s Chairman has administrative authority that other Commissioners lack, like appointing SEC staff.
Congress may have been attempting to evade the Appointments Clause by declaring in Sarbanes-Oxley that the PCAOB “shall not be an agency or establishment of the United States Government.” But as the Supreme Court observed in the Mistretta case, labels cannot change the fact that an entity is a federal agency subject to the Constitution. The fact that the PCAOB’s members are appointed by government officials and enforce federal law make it a federal agency no matter what Congress says.
In the 1995 Lebron case, Amtrak was held by the Supreme Court to be subject to the Constitution even though Congress declared that it was not a government agency. Like Amtrak, the PCAOB was created by a federal law, has a government-appointed board, and carries out federal policies. That makes it a federal agency. But the PCAOB is an even clearer example of a federal agency because, unlike Amtrak, which earns revenue from fares, the PCAOB is wholly funded through federal exactions and enforces federal laws.
The purpose of the Appointments Clause is to promote effective management by preventing the lack of accountability typical in a multi-member body, such as the appointment of poorly vetted officers through behind-the-scenes string-pulling. Vesting appointments in the President or in a single agency head makes clear who is really behind a given appointment, and makes it possible for the executive to demand good performance from the appointee.
Sarbanes-Oxley’s requirement that SEC Commissioners as a group agree on appointments of PCAOB members undermines the goal of effective management. Initial appointments proved messy and divisive. For instance, according to the Government Accountability Office, in 2002, when a divided SEC selected the PCAOB’s membership, “The selection process broke down…when the Commission was unable to agree on a consensus candidate for chairman.” Different commissioners backed different candidates, and this “inability to choose a final slate of candidates until the eve of the Commission’s vote resulted in the appointment of PCAOB members who had not been fully vetted.” The first PCAOB Chairman resigned shortly after he was appointed when his service on a company under investigation for accounting problems became public. The GAO found that no Commissioner, not even the SEC’s chairman, knew of this information before the vote, because no one was really in charge of selection.
The Constitution’s framers drafted the Appointments Clause as a check on overweening bureaucracy. As colonists, they had seen offices created by the Crown spawn yet more offices, creating what the Declaration of Independence refers to as a “multitude of new offices” and “swarms of officers to harass our people.” In its 1991 Freytag decision, the Court observed that “the power of appointment to offices” was considered by the Framers to be “the most insidious and powerful weapon of eighteenth-century despotism.” Thus, “The Clause reflects our Framers’ conclusion that widely distributed appointment power subverts democratic government.”
To discourage such abuses, the Supreme Court, in its 1995 Ryder decision, overturned disciplinary action taken by improperly appointed officials. The courts should similarly overturn the rules and actions of the PCAOB, since it is an unaccountable entity that violates the Constitution’s Appointments Clause.