The Public Company Accounting Oversight Board was established in 2002 to protect the common investors from bad accounting practices evidenced by several giant companies during that era such as Worldcom, Enron, and Tyco International. Among the provisions, was one on the appointment of a five-member Public Company Accounting Oversight Board that would oversee the audits of public companies. Since the public accounting oversight board is meant to primarily protect the interests of investors, its members cannot all come from the investment community. Appointing all members from the investment field would lead to a biased perspective in the board members. As per the provisions of the Sarbanes-Oxley Act, all board members should be independent from the accounting profession, coexisting with service in the board, divide in any of the earnings of, or obtain financial benefits from an accounting firm other than previously sanctioned benefits such as retirement benefits. This provision helps in giving proper consideration to the PCAOBs risk management operations. The PCAOB is intentionally designed to be a board of non-experts that are fairly representative of the general public investors who do not have auditing experience. SOX specifies that only two of PCAOBs members can be or have been certified accountant. Rather than basing selection on reputation in the investment community, the SEC chooses members that have been prominent in society with reputation and integrity in demonstrating commitment to the protection of investors interests (Sabarnes, 2002). In this manner, the PCAOB ensures that auditors do not dominate or control the regulatory process but also reduces the number of people on the board with recent, and relevant accounting and auditing experience, therefore, essential expertise.
In Free Enterprise Fund v. PCAOB, the U.S. Supreme Court issued a decision proclaiming the constitutionality of the PCAOB and the associated Sarbanes-Oxley Act of 2002 that created it. However, the ruling held that the provisions in the Act making PCAOB members removable only with good cause as unconstitutional in regards to separation of powers. The major consequence of this decision was that PCAOB members became removable by the SEC at will rather than based on good cause. Originally, the statute creating the PCAOB provided two layers of protection to the board members through for cause removal procedures. The SEC could only remove PCAOB members for cause, and in turn, the president could only remove the SEC commissioners for cause. This effectively created tenure protection for the PCAOB members while also withdrawing from the president any decision on whether good caused existed in the removal of an officer (Krent, 2010, p.2425). In other words, the president had no oversight over the SEC or the PCAOB such that even though he might disagree with the removal of a PCAOB member be the SEC, he is powerless to intervene unless the removal is so unreasonable as to show neglect of duty or inefficiency in office. In sum, the Supreme Court found that these limitations on both the presidents power and that of the SEC in the removal of PCAOB members was unconstitutional since the president is supposed to take care that the laws be faithfully executed. These dual layers led to a separation of powers as the Sabarnes-Oxley Act gave PCAOB members the executive powers of determining policy and enforcing laws in the United States (Krent, 2010). With dual layers of protection, the president could not be held responsible for the actions of the SEC and PCAOB as he could not influence their actions. Therefore, the judge held that rather than labelling the entire board as unconstitutional, only the removal clauses would be amended as it was in the interests of all parties concerned.
Another provision that was in question during the trial was the constitutionality of the Act establishing the PCAOB in regards to the Appointments Clause as outlined in the constitution. The President of the United States has the powers to appoint and remove officers of executive agencies of the government (Shedd et al., 2005). Removal is mostly based on for cause and is reserved for extreme cases where a public officer has consistently failed to perform his/her duties. In the trial, the Plaintiff claimed that the Act was unconstitutional as per the Appointments Clause since it stated PCAOB members as being selected by the SEC rather than the president. For this argument, the court ruled that since the SEC could review the decisions of the PCAOB, and since the PCAOB members are removable at will, the board members were inferior officers whose appointment congress could dlegate to a head of department.
The only major aspect of the PCAOBs operations that was affected by the ruling in Free Enterprise Fund vs PCAOB was the removal procedures for both the board members and the SEC commissioners which made their employment terminable at the will of the president. This has since made them more efficient and accountable for their actions as their tenure in office is not guaranteed. Additionally, the reaffirmation of the PCAOBs constitutionality forced public companies to adjust to the increased regulatory standards thus protecting investors.
Krent, H. J. (2010). Federal Power, Non-Federal Actors: The Ramifications of Free Enterprise Fund. Fordham L. Rev., 79, 2425.
Sarbanes, P. (2002, July). Sarbanes-oxley act of 2002. In The Public Company Accounting Reform and Investor Protection Act. Washington DC: US Congress.
Shedd, P. J., Morehead, J. W., Pagnattaro, M. A., & Cahoy, D. R. (2005).The legal and regulatory environment of business. McGraw-Hill/Irwin.
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