Risk Management

PCAOB Counters Legal Attack on Sarbox

The board responds to a lawsuit contending that its very existence violates the Constitution.
David KatzMay 19, 2006

In a recent move, the Public Company Accounting Oversight Board filed a motion to dismiss a lawsuit charging that the board and its rules are unconstitutional.

On February 7, the nonprofit Free Enterprise Fund and small Nevada audit firm Beckstead and Watts sued the accounting board in U.S. District Court for the District of Columbia to halt its investigation of Beckstead. The plaintiffs took their lawsuit one giant step further: they asserted that the setup of the PCAOB violates the Constitution’s separation-of-powers principal as well as its appointments clause because members of the Securities and Exchange Commission — and no one from the executive, legislative, or judicial branches of government — appoint the members of the PCAOB.

Rather than tackling the constitutional issues, however, the PCAOB seems to be mounting a technical defense. The board, which was established under the Sarbanes-Oxley Act, first contended that the plaintiffs bypassed the act’s exclusive review mechanism by pursuing their suit in district court. Under Sarbanes-Oxley, argued the board, accounting firms may challenge disciplinary sanctions only before the Securities and Exchange Commission and then before appeals courts.

Second, the accounting board contended that even if the plaintiffs are alleging constitutional breaches, they must identify a reason that they demand relief, but have not done so.

The PCAOB’s third argument for dismissal of the lawsuit is that the plaintiffs lack standing to pursue it. The board asserted that the Free Enterprise Fund, which promotes limits on government, “has simply alleged unspecified ‘members’ suffered unspecified ‘injury’ as a result of unspecified ‘regulations.’” As private parties, the motion continued, both the fund and the audit firm also lack standing to pursue certain challenges under the appointments clause; only the appointing officer can do that, the PCAOB argued.

In February, shortly after the plaintiffs filed their lawsuit against the board and its four members, some participants said they believed that a favorable outcome could spur the courts and Congress to undo the entire Sarbanes-Oxley Act. Because the act lacks a severability clause, they suggested, a negative ruling on one part could lead to a negative outcome for the whole. Other lawyers disagreed, saying that the constitutionality of various parts of the law could be decided on their own merits.

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