This is the first in our 2024 Year in Preview series examining important trends in white collar law and investigations in the coming year. We will be posting further installments in the series throughout the next several weeks.
Last week the Supreme Court heard arguments over whether federal courts should continue to apply
Chevron deference to federal agency rulemaking. While the fate of
Chevron is unknown, one thing (
as our colleague Beth Neitzel has noted) seems clear – federal agencies will face an increasingly uphill battle in defending rules that lack an express statutory basis. Enter the Public Company Accounting Oversight Board (the “PCAOB” or the “Board”), which has recently proposed a revision to its Rules that would significantly expand the reach of its enforcement power for contributory (or secondary) liability—i.e., where an accountant’s actions do not themselves amount to a violation of the applicable securities laws, rules or professional standards, but contribute to the violation of an associated accounting firm. The PCAOB’s current rule creates liability for those who recklessly or knowingly contribute to a firm’s violation. The new proposal would expand that liability to those that act with negligence. However, an analysis of the relevant statutory language and existing common law suggests that not only is this proposed expansion contrary to fundamental principles of secondary liability, but also that the PCAOB may lack congressional authority to pursue any contributory liability cases, regardless of the required mental state. Given the judiciary’s increasing hostility towards expansive administrative rulemaking, if passed and approved by the Securities and Exchange Commission (“SEC”), the PCAOB’s proposed rule will likely face withering judicial skepticism.
As part of a proposed amendment to PCAOB Rule 3502, Responsibility Not to Knowingly or Recklessly Contribute to Violations, the Board seeks to expand the scope of potential contributory liability by reducing the requisite mental state from recklessness to negligence. PCAOB Release No. 2023-007 (September 19, 2023). Current Rule 3502 provides that a “person associated with a registered public accounting firm shall not take or omit to take an action knowing, or recklessly not knowing, that the act or omission would directly and substantially contribute to a violation by that registered public accounting firm” of applicable provisions of the securities laws and regulations, as well as PCAOB Rules and professional standards. (emphasis added). If adopted, the proposed rule would remove the “knowing, or recklessly not knowing” standard and replace it with a negligence standard, creating secondary liability for individuals who “knew or should have known” that their acts or omissions would contribute to a violation. PCAOB Release No. 2023-007. Thus, under the proposed rule, even where a person makes a good faith mistake, that person could be held secondarily liable if his or her actions directly and substantially contribute to the violation of another.
The proposed change would substantially expand the scope of conduct subject to enforcement action by the PCAOB and depart from conventional standards for secondary liability, which typically require knowing or, at a minimum, reckless conduct, including, for example, aiding and abetting claims. E.g., Restatement (Third) of Torts, Liability for Economic Harm § 28 (“Liability under this Section requires proof that the defendant knowingly aided the commission of a tort. Negligence will not suffice; nor is it enough to prove that the defendant should have known of the primary actor’s wrongful conduct but did not.”). As courts have explained, “[t]he scienter requirement scales upward when activity is more remote.” Woodward v. Metro Bank of Dall., 522 F.2d 84, 95 (5th Cir. 1975); see also Primavera Familienstiftung v. Askin, 130 F. Supp. 2d 450, 508 (S.D.N.Y. 2001) (citing Edwards & Hanly v. Wells Fargo Sec. Clearance Corp., 602 F.2d 478, 484 (2d Cir. 1979)).
Against this backdrop and examining the statute authorizing the PCAOB to conduct enforcement actions, it appears that not only is the PCAOB proposing to impose secondary liability in a manner that is in tension with broadly accepted principles, but also that the PCAOB may not be authorized to pursue enforcement actions targeting secondary liability at all. In Sarbanes-Oxley, Congress created the PCAOB and authorized it to impose enforcement sanctions upon a finding that an individual or entity “engaged in any act or practice, or omitted to act, in violation of this Act, the rules of the Board, the provisions of the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants with respect thereto, including the rules of the Commission issued under this Act, or professional standards.” Sarbanes-Oxley Section 105(c)(4), 15 U.S.C. § 7215(c)(4) (emphasis added). Thus, the statutory text expressly requires that enforcement sanctions be based on an act or omission that itself constitutes a violation of applicable laws and regulations. It does not expressly authorize the Board to take disciplinary action on the basis of secondary liability, i.e., conduct that merely contributes to the violation committed by another entity or person.
Congress knows how to authorize federal agencies to pursue enforcement actions for secondary liability, including in the securities context. In Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., the Supreme Court held that the lack of an express statutory basis for secondary liability in the Exchange Act precluded aiding and abetting claims by both private plaintiffs and by the SEC. 511 U.S. 164, 177 (1994). The Court distinguished between primary and secondary liability and emphasized that Congress knew how to impose secondary liability when it intended to do so. In 1995, Congress responded to Central Bank by expressly granting the SEC the power to sanction aiding and abetting conduct. Private Securities Litigation Reform Act (“PSLRA”), P.L. 104-67, § 104 (Dec. 22, 1995) (establishing Exchange Act § 20(e), 15 U.S.C. § 78t(e)). The PSLRA authorized the SEC to impose sanctions against “any person that knowingly or recklessly provides substantial assistance to another person in violation of” applicable securities rules and regulations. Id. (emphasis added). It was only a few years later that Congress passed Sarbanes-Oxley, which does not include similar language expressly permitting the Board to pursue enforcement sanctions for secondary liability. The proposed changes to Rule 3502, if adopted, would thus result in a perverse outcome: the PCAOB’s ability to impose sanctions for secondary liability would exceed that of the SEC (requiring only negligence rather than recklessness), where the former lacks any statutory grounding while the latter is expressly authorized by statute.
The PCAOB argues in support of its proposed rule that Congress authorized it to sanction negligent conduct. PCAOB Release No. 2003-015, at A2-58 (Sept. 29, 2003) (citing section 105(c)(4) and (c)(5) of Sarbanes-Oxley and asserting that the Board has implicit authority to pursue lesser sanctions for a single instance of negligent conduct). This analysis misses a key step, however, because Sarbanes-Oxley only authorizes the PCAOB to pursue sanctions for an act of negligence that itself constitutes a violation of the applicable securities laws, regulations and other PCAOB Rules and professional standards. See 15 U.S.C. §7215(c)(4) (the “Board may impose … sanctions” based on a finding “that a registered public accounting firm or associated person thereof has engaged in any act or practice, or omitted to act, in violation of this Act, the rules of the Board, the [applicable] provisions of the securities laws … or professional standards”).
Given the judiciary’s increasing hostility towards what some view as administrative overreach, including in cases beyond those currently before the Supreme Court regarding Chevron deference, the PCAOB may have an uphill battle in attempting to expand the scope of its own enforcement power without express congressional authority. For example, the Supreme Court has recently signaled a willingness to challenge the SEC’s asserted boundaries of authority. In Axon Enterprise Inc. v. Fed. Trade Comm’n, the Court held that a respondent in an SEC enforcement action did not need to go through the SEC’s administrative courts when challenging the proceedings on constitutional grounds, but rather could proceed directly to federal court. 598 U.S. 175 (2023). In SEC v. Jaresky, the Court may be ready to strike down as unconstitutional the use of the SEC’s administrative courts to pursue civil monetary penalties. And the PCAOB is already on somewhat shaky ground. See Dkt. No. 22-859. In 2008, then D.C. Circuit Court Judge Kavanaugh expressed skepticism regarding the constitutionality of the PCAOB altogether:
Perhaps the most telling indication of the severe constitutional problem with the PCAOB is the lack of historical precedent for this entity. Neither the majority opinion nor the PCAOB nor the United States as intervenor has located any historical analogues for this novel structure. They have not identified any independent agency other than the PCAOB that is appointed by and removable only for cause by another independent agency.
Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 537 F.3d 667, 699 (D.C. Cir. 2008) (Kavanaugh, B., dissenting). In striking down Sarbanes-Oxley’s provisions restricting removal of members of the Board, the less conservative Supreme Court of 2010 was animated by concerns about the PCAOB operating without sufficient oversight by and accountability to the democratically elected branches of government.
See Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 561 U.S. 477, 499 (2010) (“The growth of the Executive Branch, which now wields vast power and touches almost every aspect of daily life, heightens the concern that it may slip from the Executive’s control, and thus from that of the people.”).
Even if Chevron deference survives the current challenges in some limited form, it seems clear that federal agencies will have a harder time justifying rules that are not grounded in express statutory authorization. Given recent judicial responses to perceived administrative overreach, the PCAOB’s move to markedly expand the scope of its enforcement actions may be ripe for challenge.
For the full series, please see: White Collar Year in Preview
