Securities Law Updates | New Judicial Opinions

August 25, 2008

DC Circuit Upholds Constitutionality of SEC Audit Panel

Free Enterprise Fund v. Public Company Accounting Oversight Board
No. 07-5127, U.S. Court of Appeals for the District of Columbia, 8/22/2008

DC Circuit Upholds Constitutionality of SEC Audit Panel


In a 2-1 ruling, the U.S. Court of Appeals for the District of Columbia Circuit ("DC Circuit") upheld the constitutionality of Title I of the Sarbanes-Oxley Act of 2002 ("Act") creating the Public Company Accounting Oversight Board ("Board"). The Board's function is to oversee auditors, while its five members are appointed by the Securities and Exchange Commission ("SEC"). Appellants Free Enterprise Fund ("Fund") and Beckstead and Watts, LLP had earlier challenged the creation of the Board, alleging violation of the Appointments Clause, separation powers and non-delegation principles of the U.S. Constitution. The U.S. District Court for the District of Columbia dismissed the Fund's suit. On appeal, the DC Circuit affirmed the grant of summary judgment to the Board. The DC Circuit specifically held, first, that the Act does not encroach upon the Appointment power. Second, the DC Circuit held that the for-cause limitations on the SEC’s power to remove Board members and the President’s power to remove SEC Commissioners do not strip the President of sufficient power to influence the Board and thus do not contravene separation of powers. In his lone dissent, Judge Brett Kavanaugh wrote that the Board's structure unconstitutionally restricts the U.S. President's appointment and removal powers.

Detailed Summary:

Congress enacted the Act, 15 U.S.C. §§ 7201 et seq., following the Enron and Worldcom accounting scandals that exposed serious weaknesses in industry self-regulatory reporting requirements for certain publicly held companies. Opinion, p. 4.

Title I of the Act establishes the Board “to oversee the audit of public companies that are subject to the securities laws . . . in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.” Id., citing 15 U.S.C. § 7211(a). The five members of the Board are appointed by the SEC after consultation with the Chairman of the Board of Governors of the Federal Reserve and the Secretary of the Treasury. Id., citing 15 U.S.C . § 7211(e)(4)(A). The Act empowers the Board, subject to the oversight of the Commission, to, among other things, register public accounting firms, establish auditing and ethics standards, conduct inspections and investigations of registered firms, impose sanctions, and set its own budget, which is funded by annual fees. Id., citing 15 U.S.C. §§ 7211(c), 7219(c), (d).

The SEC’s authority over the Board is explicit and comprehensive. Id, citing 15 U.S.C. §§ 7217, 7218. The Board could commence operations only upon the SEC’s determination that it was properly organized and had appropriate rules and procedures in place, Id., citing 15 U.S.C.  § 7211(d), and “[n]o rule of the Board shall become effective without prior approval of the Commission,” Id., citing 15 U.S.C. § 7217(b)(2). The SEC is empowered to “abrogate, add to, and delete from” the Board’s rules “to assure the fair administration of the [Board], conform the rules promulgated by that Board to the requirements of Title I of the [Act], or otherwise further purposes of that Act, the securities laws, and the rules and regulations thereunder applicable to that Board.” Id. , p. 5, citing 15 U.S.C. §§ 7217(b)(5), 78s(c).

In addition to these ex ante controls, all Board adjudications are subject to the SEC’s de novo review, Id., citing 15 U.S.C.  § 7217(c)(2); Nat’l Ass’n of Sec. Dealers, Inc. v. SEC, 431 F.3d 803, 804 (D.C. Cir. 2005) (“NASD”), upon an immediate stay when an application for review is filed or sua sponte by the SEC, Id., citing 15 U.S.C. §§ 7215(e)(1), 7217(c)(2)(A). The SEC is empowered to “enhance, modify, cancel, reduce, or require the remission of a sanction imposed by the Board.” Id., citing 15 U.S.C. § 7217(c)(3). The SEC alone determines whether the Board may “sue and be sued” in any court. Id., citing 15 U.S.C. § 7211(f)(1). A member of the Board may be censured or removed from office “for good cause shown,” Id., citing 15 U.S.C. § 7211(e)(6), upon a finding by the SEC, after notice and opportunity for a hearing, that the member willfully violated the Act or abused authority, or failed to enforce compliance with a rule or standard without reasonable justification. Id., citing 15 U.S.C. § 7217(d)(3).

This constitutional challenge to the Act was brought by the Fund, a non-profit public interest organization that “promotes economic growth, lower taxes, and limited government.” Id., citing Compl. ¶ 11. It was joined by one of its members, Beckstead and Watts, LLP (“B&W”), a Nevada accounting firm that was registered with the Board and was subject to an ongoing formal investigation that was commenced in 2005. Id. , p. 6,  citing Compl. ¶ 79.

On February 7, 2006, the Fund and B&W (collectively “the Fund”) filed a complaint alleging that the creation of the Board violated the Appointments Clause, separation of powers, and non-delegation principles. The Fund sought declaratory and injunctive relief prohibiting the Board from carrying out its duties, including taking “any further action” against B&W. The United States intervened to defend the constitutionality of the Act. The district court denied the Board’s motion to dismiss the complaint for lack of jurisdiction and granted the motions for summary judgment of the Board and the United States. Id.
The Fund appealed, and the DC Circuit’s review was de novo. Id., citing Simpson v. Socialist People’s Libyan Arab Jamahiriya, 470 F.3d 356, 359 (D.C. Cir. 2006).

The Appointments Clause provides: “[The President] shall . . . 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.” Id. p. 8, citing U.S. CONST. art. II, § 2, cl. 2.

According to the DC Circuit, the plain text of the Appointments Clause contemplates that Congress may lodge the appointment power of inferior officers in entities other than the President. The Fund argued, however, that the absence of day-to-day supervision of the Board by the SEC and the for-cause limitation on the Commission’s power to remove Board members means that Board members are not inferior officers and therefore must be appointed by the President. Alternatively, the Fund argued that even if Board members are inferior officers, they cannot be appointed by the SEC because the SEC is not a “Department” and the SEC Commissioners are not its “Head.”

The DC however rejected such arguments. The DC Circuit held, first, that the Act does not encroach upon the Appointment power because, in view of the SEC’s comprehensive control of the Board, Board members are subject to direction and supervision of the SEC and thus are inferior officers not required to be appointed by the President.

Second, the DC Circuit held that the for-cause limitations on the SEC’s power to remove Board members and the President’s power to remove SEC Commissioners do not strip the President of sufficient power to influence the Board and thus do not contravene separation of powers, as that principle embraces independent agencies like the SEC and their exercise of broad authority over their subordinates.

In view of the foregoing, the DC Circuit affirmed the district court’s grant of summary judgment to the Board.

View a PDF of the judicial opinion

Companies Mentioned

Beckstead and Watts, LLP

Free Enterprise Fund

Public Company Accounting Oversight Board

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Companies Mentioned

Securities Law

The following companies are mentioned in Securities Law Updates:

Securities and Exchange Commission

Harris Associates, L.P.

Banc of America Securities LLC

Citicorp USA, Inc.

The Public Employees’ Retirement System of Mississippi

Morgan Stanley & Co., Inc.

Jan Charles Finance S.A.

Park East, Inc.

CIBC World Markets Corp.

Citigroup Inc.

Barclays Capital Inc.

Citigroup Global Markets, Inc.

Societe Generale

SunTrust Bank

TD Securities (USA), Inc.

BMO Nesbitt Burns Corp. n.k.a. Harris Nesbitt Burns Corp.

Consolidated Leasing Hugoton Joint Venture #2

Buchanan Ingersoll & Rooney Professional Corporation

Consolidated Leasing Anadarko Joint Venture

W. R. Huff Asset Management Co., LLC

Guardian Capital Management


Vesta Insurance Group, Inc.

Free Enterprise Fund

Banc of America, N.A.

Torchmark Corp.

Beckstead and Watts, LLP

Barclays Bank PLC

KPMG Peat Marwick, LLP

Deloitte & Touche LLP

Public Company Accounting Oversight Board

BNY Capital Markets, Inc.

Florida State Board of Administration

Credit Suisse Securities (USA) LLC

Credit Lyonnais Securities (USA) Inc.

The Cleaners & Caulkers Local 1 Pension Fund

Credit Suisse, New York Branch

Ameriprise Financial, Inc. f.k.a. American Express Financial Corp.

Deutsche Bank AG

California Department of Corporations

The Royal Bank of Scotland plc

RiverSource Investments, LLC

Harris Nesbitt Corp.

Consolidated Management Group, LLC

The Bank of Nova Scotia

Asset Management Holding AG

Deutsche Bank

Toronto Dominion Texas, LLC f.k.a. Toronto Dominion Texas, Inc.

Alex Brown, Inc.

Tellabs, Inc.

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