- Kramer Levin attorneys examine SEC v. Jarkesy impact on PCAOB
- In-house tribunal restrictions may apply to board proceedings
The viability of the Public Company Accounting Oversight Board's enforcement proceedings is in question following the US Supreme Court's decision in SEC v. Jarkesy, because the PCAOB has no statutory authority to bring such proceedings in federal court.
The court held that the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties for securities fraud. That means the SEC can't compel the defendant to adjudicate such claims in the agency's in-house tribunals.
Like the SEC, the PCAOB conducts investigations and can bring disciplinary proceedings against registered public accounting firms and associated persons. The PCAOB's purview is limited to alleged violations of the Sarbanes-Oxley Act of 2002, PCAOB rules, professional standards, and securities laws "relating to the preparation and issuance of audit reports and liabilities of accountants with respect thereto." A board-appointed in-house hearing officer conducts the proceedings confidentially and can impose civil monetary penalties, censures, and bars or suspensions from association with a registered public accounting firm.
PCAOB Chair Erica Williams has emphasized the board's "renewed vigilance" in pursuing its enforcement agenda. According to the board's annual reports, total penalties have soared from about $1.2 million in 2021, to more than $20 million in 2023. This past April, the PCAOB announced a record $25 million penalty against one firm.
Jarkesy may change all that. The Supreme Court has treated the PCAOB as part of the government, like the SEC. This suggests the Seventh Amendment, as interpreted in Jarkesy, applies to PCAOB proceedings as well as SEC in-house tribunals. Consequences for the PCAOB may be more far-reaching than for the SEC for several reasons.
Potential Impact
The PCAOB's authority to bring enforcement proceedings is more limited. It doesn't have the federal court option that the SEC does, although it may refer an investigation to the SEC or other federal regulators.
Jarkesy explained that the Seventh Amendment applies to "suits at common law," which include claims that are legal in nature. Whether a claim is legal in nature turns on whether the remedy is "designed to punish or deter the wrongdoer" and whether the cause of action resembles a common law claim.
Defendants will argue that any claims for monetary remedies the PCAOB brings are legal in nature because the PCAOB can impose only civil penalties designed to punish and deter, not to compensate. Jarkesy held that a request for such penalties is "all but dispositive" in determining that a defendant has a constitutional right to a jury trial.
Defendants also will argue that Jarkesy raises a question as to whether the PCAOB can bring proceedings before its in-house tribunal for non-monetary sanctions such as censures, bars, and suspensions based on what resembles a common law claim because those sanctions too are designed to punish or deter.
Jarkesy didn't expressly address this issue, but one of the SEC's sanctions in that case was a bar from participating in the securities industry and in offerings of penny stocks.
Although Jarkesy concerned a fraud claim, the court's reasoning applies to other common law claims. Defendants will argue that the Seventh Amendment applies to many or most of the PCAOB's claims because they resemble common law claims, including fraud, negligence, malpractice, and other torts, and are therefore legal in nature.
The PCAOB may argue that its disciplinary proceedings fit within the "public rights exception." But Jarkesy made clear that an action "presumptively concerns private rights" rather than public rights if it resembles traditional common law claims, even for "novel statutory regimes."
It would be anomalous if the SEC couldn't bring an in-house proceeding against the perpetrators of an accounting fraud, but the PCAOB could bring such a proceeding against accountants for their alleged failure to prevent the fraud.
Broader Constitutional Questions
Jarkesy raises the question of whether the PCAOB's in-house proceedings run afoul of other constitutional protections. The Supreme Court wrote that to "permit Congress to concentrate the roles of prosecutor, judge, and jury in the hands of the Executive Branch" is "the very opposite of the separation of powers that the Constitution demands."
Chief Justice John Roberts noted that the SEC's in-house forum affords fewer procedural protections than federal courts with respect to "who presides and makes legal determinations" and "what evidentiary and discovery rules apply." The same is true of the PCAOB.
Beyond that, Jarkesy didn't reach two issues on which the US Court of Appeals for the Fifth Circuit ruled against the SEC in that case. The first is whether the statute allowing the SEC to choose a forum, without "adequate guidance" from Congress, violated the nondelegation doctrine.
The second is whether insulating SEC administrative law judges "from executive supervision with two layers of for-cause removal protections violated the separation of powers." These issues also could have ramifications for the PCAOB.
The SEC has recognized that the PCAOB's hearing officers are similar to the SEC's ALJs. Defendants may argue that the hearing officers' broad authority under PCAOB Rule 5200 "to do all things necessary and appropriate to discharge his or her duties" violates the separation of powers. The PCAOB is a private corporation that's subject to limited oversight and can singlehandedly decide whether to bring charges.
Even before Jarkesy, the PCAOB contended with lawsuits challenging the constitutionality of its in-house proceedings.
An unnamed accountant is seeking to enjoin the PCAOB from "continuing its unlawful and unconstitutional prosecution of him in secret disciplinary proceedings." The case, originally filed in Texas, is pending in the US District Court for the District Of Columbia. Another accountant filed a similar complaint in the US District Court for the Middle District of Tennessee.
Jarkesy's emphasis on "vindicat[ing] the Constitution's promise of a fair trial in a fair tribunal" may give further impetus to such claims. Justice Brett Kavanaugh, before his elevation to the Supreme Court, characterized the PCAOB's structure as an "unprecedented extra-constitutional stew."
The case is SEC v. Jarkesy, U.S., No. 22-859, 6/27/24.
Originally published by Bloomberg Law
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