Constitutionality of the Public Company Accounting Oversight Board: U.S. Supreme Court Concludes That Only the Tenure Provisions of the Sarbanes-Oxley Act Governing the Removal of PCAOB Members Are Unconstitutional

Sullivan & Cromwell LLP - June 30, 2010

One of the primary changes instituted by the Sarbanes-Oxley Act of 2002 (“SOX”) was the creation of the Public Company Accounting Oversight Board (the “Board”) to regulate participants in the accounting industry and to promulgate accounting and auditing rules. The Board’s members are appointed by the Securities and Exchange Commission (the “Commission”) and, in accordance with SOX, could be removed by the Commission only “for cause.” In Free Enterprise Fund et al. v. Public Company Accounting Oversight Board et al., No. 08-861 (June 28, 2010) (“Free Enterprise Fund”), plaintiffs challenged the constitutionality of the Board and sought an injunction preventing the Board from exercising its powers.

In a 5-4 decision, the U.S. Supreme Court declared unconstitutional the provision of SOX allowing removal of Board members only “for cause.” The majority concluded that SOX violated principles of the separation of powers because it improperly shielded the Board from direct Presidential oversight, given that the President could remove an SEC commissioner only “for cause” and the Commission, in turn, could remove a Board member only “for cause.” The Court remedied this constitutional deficiency by invalidating these tenure restrictions and thus making members of the Board removable by the Commission at will.

The Court did not otherwise limit the validity of SOX, holding that “[t]he Sarbanes-Oxley Act remains ‘fully operative as a law’ with these tenure restrictions excised.” This decision, the Court explained, does not affect the validity of rules promulgated or actions taken by the Board either before or after the decision. The Court’s opinion, however, leaves unanswered questions regarding the validity of “for cause” restrictions on the removal of other “inferior officers” within agencies and departments of the Executive Branch.