OUR THOUGHTS ON:

The PCAOB Survives Constitutionality Challenge

Public Companies

By Shawn Edwards

The Public Company Accounting Oversight Board (PCAOB) was created by the Sarbanes-Oxley Act of 2002. In February 2006, a lawsuit filed in the federal District Court in Washington, D.C. challenged the constitutionality of the PCAOB.

In the lawsuit, petitioners, including The Free Enterprise Fund, a non-profit organization focusing on limited government and tax relief, argued that the PCAOB violates the Constitution by eliminating the ability of the President to oversee and control the PCAOB’s powers and to appoint the PCAOB’s Board members. Instead, these functions were handled by the Securities and Exchange Commission (SEC), creating a multilevel layer of protection for the PCAOB. The lawsuit further argued that the PCAOB exerts extensive powers by allowing it to levy taxes on public companies and regulate the accounting industry with no direct oversight or accountability to one of the three main branches of government.

On June 28, 2010, the Supreme Court agreed with aspects of the lawsuit filed by the Free Enterprise Fund. In a 5-4 decision, the Supreme Court held that the Sarbanes-Oxley Act’s provisions making PCAOB Board members removable by the SEC only by reason of good cause were inconsistent with the Constitution. However, the Supreme Court ruled that these specific provisions could be severed from the Act, allowing the SEC to remove the PCAOB Board members at will. The PCAOB itself has not been ruled unconstitutional; that ruling applies only to the way its members are appointed. The PCAOB may continue to operate as it has in the past, and the Sarbanes-Oxley Act remains law. As such, it may be understood that the court rejected a transparent attempt to undermine the Sarbanes-Oxley Act reforms that have served our financial markets well.

Indeed, SEC Chair Mary Schapiro was quoted: “I am pleased that the court has determined that the board’s operations may continue and the Sarbanes-Oxley Act, with the board’s tenure restrictions excised, remains fully in effect. The PCAOB is a cornerstone of the Sarbanes-Oxley Act and serves a critical role in promoting investor protection and audit quality. We look forward to continuing to work with the board in connection with its mission to oversee auditors in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports.”

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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax-related matter.

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