Free Enterprise Fund and Beckstead and Watts, LLP v. Public Company Accounting Oversight Board

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Argued December 7, 2009.

Authorship: Lyle Denniston of SCOTUSblog

Docket: 08-861

Issue: Whether the Sarbanes-Oxley Act is consistent with separation-of-powers principles - as the Public Company Accounting Oversight Board is overseen by the Securities and Exchange Commission, which is in turn overseen by the President - or contrary to the Appointments Clause of the Constitution, as the PCAOB members are appointed by the SEC.

Contents

Briefs and Documents

Oral Argument

Transcript (December 7, 2009)

Merits Briefs

Amicus Briefs

Certiorari-Stage Documents

Oral Argument Recap

The Supreme Court’s major precedents on the President’s control over the Executive Branch may be few in number, but they seem to have left a legacy of complexity that makes it hard for Justices to see grand constitutional themes amid all of the details. In the latest review of that core structural question on Monday, the Court dwelled at great length on finite facts before Justice Samuel A. Alito, Jr., finally broke through to the basic point.

For much of the oral argument in Free Enterprise Fund v. Public Company Accounting Oversight Board (08-861), it sounded as if the Court would never get beyond the specifics of the way that Board does it work — and is (or is not) supervised — under the Sarbanes-Oxley Act creating that new agency to monitor the auditing of corporate finance. Washington lawyer Michael A. Carvin, seeking to mount a sweeping attack on the Board’s supposedly unchecked power to use governmental power, was bedeviled repeatedly by probing questions on mundane operating details.

Without exception, Justices seemingly of differing perspectives on the separation-of-powers questions that are lurking in Sarbanes-Oxley, wanted to know just how the Board worked, and just what its relationship was with the one federal agency that seems to have some oversight of it: the Securities and Exchange Commission. So, for all of his first stint at the lectern, Carvin was able to launch few rhetorical flourishes about the perceived threat to the Presidency from a free-lancing regulatory board not under his Executive thumb.

The pursuit of the technicalities was so diligent that Justice Stephen G. Breyer sparred with Carvin over whether any federal statute regulated the President’s power to fire an SEC chairman or commissioner — as if that would settle anything about the President’s lack of power over the members of the accounting Board.

When the defender of Sarbanes-Oxley’s creation of the Board, U.S. Solicitor General Elena Kagan, took the lectern, it seemed as if the substance would not change. She spent most of her opening minutes on her point that the Board can hardly do anything without having to look over its shoulder to see whether it was pleasing to the SEC.

Her portrait of a abjectly subordinate Board was so vivid that, at one point, Chief Justice John G. Roberts, Jr., was led to wonder why Congress had set up ”a separate board if it’s going to be entirely controlled by the SEC.” Still, that and other exchanges showed that the argument was still focused on the Board-SEC links, not on the ultimate question of the President’s prerogatives.

Finally, midway through Kagan’s presentation, Justice Alito stepped in for the first time. ”As a practical matter,” he asked, ”does the President have any ability to control what the Board does?” Kagan replied that the Chief Executive has as much power to do so as he has to oversee what the SEC does. Alito was not persuaded. He wanted to know if the President, objecting to the very large salaries that the Board’s members are paid, could do anything to change them. Kagan said the President or one of his aides could call up the SEC and express his outrage.

Slyly, Justice Antonin Scalia suggested that the President could only ask “would you please change it?” Scalia said even he could do that, implying that his intervention would have as much effect as the President’s. Kagan then conceded that the President can’t order around the SEC members.

The exchange had the positive effect of bringing the Court back to the foundation question, not of the Board-SEC relationship, but with the President-Board relationship. Kagan insisted that Sarbanes-Oxley does not “go an inch further” in limiting presidential power than the Court had gone in the 1935 precedent in Humphrey’s Executor v. U.S.

Chief Justice Roberts then joined more actively in the fray, suggesting that Sarbanes-Oxley introduces an entirely new limit on presidential authority to fire those carrying out Executive functions, by putting the President an additional layer away from controlling the Board. The Act, Roberts said, “goes further because you have got to rely on the SEC to get to the Board.” Alito chimed in, saying that “the more layers” of limits on presidential removal power “the less control the President has.”

Those were exactly the kinds of exchanges that Carvin had wanted to stimulate, because in those lies the separation-of-powers arguments he was pressing.

Speaking for the Board itself, Washington lawyer Jeffrey A. Lamken devoted his time, as he did his brief, to reinforcing Kagan’s arguments about how pervasive SEC oversight of the Board is. “It is the judgment and the decision of the SEC that controls. The Board can propose, but it’s the SEC that decides.” In time, however, the Justices who are skeptical of Sarbanes-Oxley put the focus back on presidential power.

Justice Scalia, for example, asked rhetorically: “Congress set up that agency to be independent from the President. That was the whole purpose of it, wasn’t it?”

Carvin spent his rebuttal time trying to drive home his defense of presidential authority, and the plight of that authority in the wake of Sarbanes-Oxley. What Kagan and Lamken had been arguing, Carvin said, were merely “fictional realities” about SEC’s power to rein in the Board. “This Court has emphasized countless times,” he said, “that your analyze separation of powers cases with respecdt to the practical consequences…with respect to bright lines and high walls..and with great skepticism of Congress’s subtle encroachments.”

Argument Preview

Lyle Denniston wrote the following for SCOTUSblog on December 3, 2009.

A central feature of the scandal-inspired ”Sarbanes-Oxley Act” — the creation of a new private/public agency to watch over major accounting firms — has been under heavy constitutional challenge since soon after the Act was passed seven years ago. That challenge is now before the Court. The Justices, however, are being urged by the government and the new agency not to reach the constitutional issue. If the Court does rule on it, the result could be a historic decision on power-shifting between the Presidency and Congress.

Background

The division of powers among the three Branches of the national government has been a topic of lively dispute since even before the Founders wrote the Constitution. Despite its importance, the issue has produced only a few — though highly significant — rulings by the Supreme Court. In recent years, the controversy has reached a new intensity with the rise of an energetic campaign to revitalize presidential power, to enhance the Chief Executive’s role as the single leader of that Branch. Within the Supreme Court, that effort has had its own champion — Justice Antonin Scalia.

Lying just below the surface of this campaign is the ongoing resentment, especially in some academic and legal circles, of the “Fourth Branch” of the federal government: the independent regulatory agencies. Some of the most important pronouncements by the Supreme Court on separation-of-powers issues have come in cases involving the powers of those agencies, and their relationship to the President and the Executive Branch.

Not since 1988, when Justice Scalia dissented alone as the Court (in Morrison v. Olson) upheld Congress’s creation of the scandal-monitoring Office of Independent Counsel, has the separation-of-powers debate produced a case with more potential significance than in the new test of Congress’s more recent response to another scandal. In 2002, in the wake of the auditing manipulations that destroyed Enron Corp. and its accounting firm, Arthur Andersen LLP, hit other major companies, like Worldcom, and cost investors hundreds of billions of dollars, Congress enacted the Sarbanes-Oxley Act (named for its congressional sponsors).

After generations in which investors, the government and corporate America had relied upon the ethical standards of the private accounting profession to keep businesses honest in their financial records, Congress decided it was time to make this a public — or, at least, a quasi-public — function. Ending the system of self-regulation, Congress created a new agency entirely independent of the auditing profession. It is the Public Company Accounting Oversight Board.

The Board, set up as a private corporation but clearly exercising government-like powers, has sweeping authority to create auditing standards and enforce them against accounting firms that audit companies whose stock is traded publicly. It has five members, named for five-year terms. The members are appointed and may be removed (with some limits on that power) by the Securities and Exchange Commission. And therein lies the core of the constitutional controversy.

The challengers have contended that, in setting up the Board that way, Congress stripped the President “of all power to appoint, remove or otherwise supervise” the members and their work. “The Act,” the challengers have told the Court, “gives the President absolutely no oversight over PCAOB activities, through the power of removal or otherwise.” What Congress actually has done, they have said, is to begin with a “Fourth Branch” agency — the SEC — and leverage it into the creation of “an unprecedented ‘Fifth Branch’ of ‘private’ corporations with massive power and no Presidential oversight.”

In September 2005, the Board disclosed that it was investigating a small Nevada accounting firm, Beckstead and Watts LLP. The Board found “deficiencies” in eight of 16 audits by that firm that it had investigated. (Since then, the Board has taken no further action in that probe.) Because that firm audits publicly traded companies, it was required by Sarbanes-Oxley to register with the Board and to obey its standards.

In response, Beckstead and Watts, joined by a group that advocates limited government and economic liberty, the Free Enterprise Fund, sued the Board and the federal government in federal court. The firm sought an order blocking the Board from taking any further action against it. With the Fund, of which Beckstead and Watts is a member, the firm also argued that the Act’s creation and empowerment of the Board were unconstitutional.

The challenge failed, in a March 21, 2007, decision by U.S. District Judge James Robertson in Washington, D.C.,. and in a 2-1 ruling by the D.C. Circuit Court on August 22, 2008. The Circuit Court denied en banc review by a 5-4 vote. Last January 5, the Fund and Beckstead and Watts filed a petition for review in the Supreme Court.

Petition for Certiorari

The petition did not seek to wage all-out constitutional war over the “Fourth Branch” as a whole, or over independent regulatory agencies in general. It nonetheless mounted a sweeping constitutional complaint about the specifics of the Sarbanes-Oxley Act, and thus, at least by implication, appeared to be urging the Court to revisit some basic concepts in separation-of-powers doctrine.

Three questions were raised: does the exclusion of the President from control over selection and operation of the Board violate separation-of-powers doctrine in general, because the Act involves a move by Congress to severely restrict presidential authority; are the Board’s members “inferior officers” (within the Constitution’s meaning of that phrase) under the SEC’s restricted oversight so that their selection satisfies the Constitution’s Appointments Clause, and, if the members are “inferior officers,” does it violate the Appointments Clause because the SEC is not a “Department” of government with appointment powers.

“The issues presented,” the petition asserted, “go to the heart of the relationship between the Legislative and Executive Branches.” It is a novel case, the petition said, “because it involves a wholly unprecedented model fro federal agencies.” The Circuit Court ruling upholding the Board, it went on, “expressly authorizes Congress to enact a sea change in the structure of the federal government and strip the President of his most basic means for carrying out his constitutional duties through subordinates.”

The petition was filled with dire assessments of the threat it saw to the basic structure of the federal government, arguing that, in Sarbanes-Oxley, Congress “deliberately sought to test the outer boundaries of its ability to reduce Presidential power, by establishing a ‘Fifth Branch’ of the Federal Government, over which the President has markedly less control than he exercises over traditional ‘Fourth Branch’ independent agencies like the SEC.” Before this case, it added, quoting the dissenting judge in the Circuit Court, agencies like the SEC represented “the outermost constitutional limits of permissible congressional restrictions on the President.”

Motivated to insulate the Board from partisanship, the petition said, Congress opted to deny the President the same authority to select or remove regulators that the President has for every other independent agency. It is clear, the petition asserted, that the duties the Board members perform involve such governmental power that “they are principal officers under the Appointments Clause, who must be appointed by the President and confirmed by the Senate.”

Urging Court review even though lower courts have not divided on the specific constitutional question of the Board and its powers, the petition suggested that “none of the Court’s cases on the Constitution’s structural protections” have involved such a split. Quoting James Madison, it said that this case, like those others, demonstrates the threat that Congress has always posed to the coordinate Branches of the federal government.

The Justice Department countered on April 10, adding a question of its own: whether the federal courts had authority to decide the challenge, because Beckstead and Watts failed to try a challenge to the Board’s investigation in the procedural machinery that Congress explicitly created. If the Board seeks to impose some disciplinary punishment for an accounting violation, the Act provides that the accounting firm may ask the SEC to review it. If that review is sought, by the firm or by the SEC acting on its own, any disciplinary action is temporarily blocked. The SEC can modify or even scuttle any sanction sought by the Board. After the SEC acts, an accounting firm may then take its case to court — that is, to a federal appeals court.

The Nevada firm bypassed those review procedures, instead going straight to court, the Justice Department noted. The Department said that, since 1934, the SEC machinery for reviewing claimed violations of the securities law has been the exclusive mechanism for challenges. Beckstead and Watts could have used the parallel procedures created in Sarbanes-Oxley to test the Board’s case against it, but opted to sue first, the Department noted. Moreover, the Department contended, there was no final agency action that the accounting firm could challenge in court.

“None of the Court’s previous cases involving Appointments Clause and removal-power claims featured a free-floating facial challenge of the kind” advanced by the firm here, the Department added.

The jurisdictional question, it argued, arises at the outset of the case, and that alone should lead the Court to deny review.

The lower courts had rejected the jurisdictional argument of the government, finding that the review procedures set up by Congress apply only after the Board had issued a rule or an order, which had not happened in the Beckstead and Watts case.

The Department’s response to the petition did address the constitutional challenges, arguing that the Circuit Court was right in finding the Board members to be “inferior officers” under the Constitution, and are properly subject to the oversight of the presidentially-appointed members of the SEC. And, the Department contended, the SEC is like a Cabinet department, in the sense that it subject to presidential oversight.

In addition, the Department rejected the separation-of-powers complaint, saying Congress in creating the Board as it did was simply imposing limits on presidential removal power that the Court itself had ratified in the 1935 decision in Humphrey’s Executor v. U.S., limiting the President’s power to remove members of the Federal Trade Commission. Moreover, it argued, the new Board is not really a novel creation after all: it was modeled on self-regulatory agencies like the New York Stock Exchange.

The Board itself, responding to the petition, also advanced the jurisdictional issue, saying that the failure to exhaust the remedies laid out by Congress takes away the authority of the Supreme Court to decide the case at all. In a sharp rhetorical thrust, the Board notes that “the Executive Branch — through two different administrations — has consistently denied that is powers have been invaded” by Sarbanes-Oxley.

Moreover, the Board contended, the challengers simply misread the Act by giving it “unreasonable constructions…to manufacture constitutional defects where none exist.” When the Act is read properly, according to the Board, what the challengers treat as a “mountain” is “at best a ‘molehill.’ ”

In reply, the Fund and the accounting firm sought to dismiss the jurisdictional objections as “frivolous” and “feeble.” Their challenge, they noted, is not to any administrative action by the Board or by the SEC, but to the fundamental question of the Board’s constitutionality. An administrative review process, it contended, cannot supplant a right to go to court to test the very existence of a government entity with wide powers over the citizenry.

The Court granted review of the case on May 18; it did not limit its review to any specific questions raised by the petition. The order also did not comment on the government’s jurisdictional argument, although that is expected to be a part of the argument when the Court hears the case.

Merits Briefs

The Fund and the accounting firm used their merits brief to buttress their specific constitutional claims with lessons of history and elementary civics, arguing that what it actually at stake in the case is the Founders’ design of a balanced government with separated powers, to assure the people’s “liberty” and to enable the “sovereign” people to know “which branch to hold accountable for unpopular or ineffective government action and policies,” so they can correct those problems through the ballot box.

While not explicitly arguing for unlimited presidential power to remove any official who performs Executive functions, their merits brief does speak in expansive terms about the concept of Executive authority lodged in a single President, subject only to exceptions and qualifications directly laid down by the Constitution itself.

And the rhetoric rose in intensity in that brief. “The Framers and this Court have been explicit about the greatest threat to those separated powers and liberty: Congress. Quoting James Madison in Federalist Paper No. 48, the brief said that the “legislative department is everywhere extending the sphere of its activity, and drawing all power into its impetuous vortex.”

In a clever touch, the Fund and firm’s brief quoted, as an authority in support of its argument, a Harvard Law Review article published in 2001 by Elena Kagan — now, the U.S. Solicitor General, who will be defending the Sarbanes-Oxley Act in this case. In the article, Kagan is quoted as saying, “successful insulation of administration from the President…will tend to enhance Congress’s own authority over the insulated activities.” The quotation is used to make the point that the power of the independent agencies tends to enhance congressional authority at the expense of presidential power.

The government’s merits brief — which speaks not only for the United States but also for the SEC — renewed the contention that the Fund and the accounting firm were trying to raise in court “claims that Congress has required to be presented in the first instance to the SEC, under special procedures, with subsequent judicial review in a court of appeals.” What this lawsuit attempted to do, the federal brief said, was to short-circuit a Board investigation and to wipe out the Board’s earlier actions in that probe. “Bedrock principles of administrative law preclude that course, which deprived the SEC of the opportunity to address statutory questions” that are embedded in the constitutional challenge, the brief added.

Again, as in its response to the certiorari petition, the government sought to put forth an image of an SEC overseer of the Board with such pervasive authority as to leave no doubt that the Board’s members are “inferior” not only in a constitutional sense, but in an operational sense as well.

Reaching the constitutional issues, the federal brief put emphasis on the fact that the challengers did not dispute the constitutionality of independent regulatory agencies in general, and did not dispute Congress’s power to put limits on removal of Executive officials when they are, in fact, “inferior” officers. Harking back, once again, to the Humphrey’s Executor ruling in 1835, the brief said that the precedent “remains good law,” and supports the notion that, under Sarbanes-Oxley, the President retains sufficient control over the Board, through the SEC. “ It summed up: “This case at bottom involves authority Congress has possessed since Humphrey’s Executor, and this Court should affirm the decision below on that basis.”

The Board’s merits brief once again put its heaviest emphasis on the SEC’s powers over its members and the Board’s operations. It also repeated its argument that the Court should not parse the Sarbanes-Oxley Act in a search for constitutional violations, but rather should follow its usual practice of construing its provisions precisely to avoid such constitutional doubt.

Both the Board’s brief, and the federal brief, sought specifically to counter the challengers’ argument that Congress was using its legislative authority to enhance its powers at the President’s expense. The Act adds nothing to Congress’s powers vis-a-vis the Executive, they contended.

There is a notable imbalance in the amici briefs filed in the case — almost 2-to-1 in favor of those supporting the constitutional challenge. Perhaps that reflects an underlying reality that disputes over enhancing or curbing the power of the Executive tend to arouse more fervor among the proponents of the Executive. The majority of the amici on that side of the case are conservative advocacy groups that, in the main, tend to be suspicious of lodging governmental powers in politically unaccountable entities. Among them are free-market devotees like the Cato Institute.

There is considerable more assertiveness on presidential power than the challengers themselves put forth in their filings. For example, a group of law professors known as advocates of conservative views use strong language in urging the Court to rule that Presidents do have power to remove, at will, anyone exercising Executive power — essentially, to undo the perceived inhibitions on that power that really began with the Humphrey’s Executor ruling in 1935 and became perhaps most pronounced in Morrison v. Olson in 1988.

Three former Attorneys General identified with the “unitary Executive” concept — William P. Barr, Edwin Meese III and Richard Thornburgh — join in the case as amici, arguing that a restoration of Executive removal power is critical to preventing the Board from “continuing to wreak havoc on public companies, small businesses, and shareholders.”

There is also an amicus on that side — the Coalition for Fair Lumber Imports — that perceived the fight over Sarbanes-Oxley as also a fight over international trade dispute resolution, under commercial treaties such as NAFTA — the North American Free Trade Agreement.

On the other side, the SEC and its powers over the Board got a ringing endorsement from seven former SEC chairmen, arguing that the oversight has actually worked as Congress intended, and arguing the virtue of taking public company auditing oversight away from the private accounting profession.

Consumer, investor and labor groups also defended the new regulatory structure, and a group of professors of constitutional and administrative law entered the case to argue against expanded Executive authority, and, especially, unchecked removal power over Executive officials. The professors, in a footnote, also added support for the notion that the challengers did not have a right to bring their lawsuit in the first instance. Analysis

Potentially, this is a momentous case. The Court, as urged in several of the briefs, could go back to first constitutional principles, and seek to define anew the structural norms that are to govern the creation and allocation of new federal powers. It is quite anomalous, to be sure, that the fervent defenders of the powers of the Presidency do not include — at least in this case – the Executive Branch itself. Whether that will have an impact on the Court is unclear; perhaps the Justices will conclude that, if the Executive is not troubled about its prowess, there is no need for the Judiciary to fret on its behalf.

If the Court has any eagerness to reach the fundamental constitutional questions, this case clearly would give it that option. The particular structure Congress built in Sarbanes-Oxley may be somewhat novel, but that could as easily support the notion that Congress had over-reached as it could the contrary notion that this is not a big deal at all. The government’s efforts to suggest that this is not much different than letting the Stock Exchange police itself may well be seen as an understatement of what Congress has done.

This is a Court that, in recent years, has not shied from addressing basic questions of constitutional structure, and has not hesitated to find violations of separation-of-powers doctrine. And, though perhaps too much could be made of this, it did grant review of a core constitutional controversy that it could simply have bypassed, as the government had advocated.

If, however, the Court is hesitant to take on the profound constitutional issues that are in the case, it has available two alternatives: first, to find that the challengers were premature in bringing their lawsuit, and should try first to test their rights administratively, or, second, to interpret the provisions of Sarbanes-Oxley narrowly so as to avoid the constitutional implications that the challengers see in the sweep of the Act.

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