PCAOB sued over ‘secret disciplinary proceedings’

The Public Company Accounting Oversight Board is on the receiving end of a lawsuit filed by a civil liberties group for penalizing an unidentified accountant. 

The New Civil Liberties Alliance filed a complaint Thursday in the U.S. District Court for the Northern District of Texas seeking declaratory and injunctive relief from the PCAOB, claiming the audit overseer used “secret disciplinary proceedings” to unconstitutionally prosecute the unnamed accountant. 

The plaintiff is referred to only as “John Doe” and is described as an accountant who previously worked as an auditor at an accounting firm in the South American country of Colombia that is a member of a larger international network of accounting firms. In 2015, the accountant worked on a team that performed “component audit procedures” relating to a publicly traded audit client to help a different member firm within the network, which was the principal auditor of the client’s financial statements.

Last month, the PCAOB sanctioned KPMG’s member firm in Colombia and three of its auditors after they agreed to settlements (see story). However, an attorney with the NCLA declined to comment on whether the cases were related.

The lawsuit was filed in Texas because the PCAOB, which is based in Washington, D.C., is registered to do business in Texas and has two offices there in Houston and Irving.

The PCAOB alleged that the accountant altered or instructed others to alter audit workpapers and interfered with its investigation when he denied engage in misconduct.

Last February, the PCAOB contacted his attorneys threatening to initiate disciplinary proceedings against the accountant, alleging he failed to cooperate with their inspection and investigation of a component audit related to the client’s fiscal year 2015 financial statements, but did not threaten any charges that questioned the quality of the underlying audit work, according to the complaint. To settle the expected charges, he would have to agree to a lifetime bar and a $150,000 penalty, which at the time would have been the highest penalty imposed by the board in a settlement against an individual accountant in its 20-year history.

The demanded penalty was multiple times the amount of the accountant’s annual salary in Colombia at the time when the audits were conducted. The lifetime bar would have prohibited him not only from working on audits of issuers, brokers or dealers, but also from being associated in any capacity with a registered public accounting firm, even on non-U.S. engagements. Last month, the PCAOB instituted formal disciplinary proceedings, but the accountant continues to deny the allegations and is taking the board to court.

“He refused to accept the settlement offer, so we’re going forward with a contested proceeding where he has the right to defend himself” said NCLA senior litigation counsel Russ Ryan.

The NCLA claims the PCAOB sought to strip its client of his livelihood and impose quasi-criminal monetary penalties without a jury trial, due process, an impartial adjudicator or any constitutional accountability. In its lawsuit, the group argues that the overseer’s prosecution is being funded by money raised and spent in violation of the appropriations, taxing and spending clauses of the Constitution and the separation of powers principles inherent in those clauses.

It also contends the PCAOB’s disciplinary proceedings deprive the accountant of his right to a jury trial in violation of the Seventh Amendment, and that the board’s disciplinary process is systematically biased, secretive and unfair in violation of the due process clause of the Fifth Amendment and the Sarbanes-Oxley Act of 2002. The NCLA often files lawsuits against the Securities and Exchange Commission, the Internal Revenue Service and other government agencies as part of its public interest litigation work, usually on behalf of conservative and libertarian causes. 

“We’re asking the court to stop this outrageous example of ‘peekaboo prosecution’ — private, unaccountable actors using secret proceedings to prosecute and punish people without meaningful government oversight, no jury trial, inherently biased adjudicators, and woefully deficient due process protections,” said Ryan in a statement. “The Sarbanes-Oxley Act created this uniquely extra-constitutional machinery 20 years ago, and it’s past time for the courts to shut it down.”

The PCAOB has been trying to put a greater emphasis on enforcement under a mostly new set of board members who joined last year, after complaints that the board had grown too lax in overseeing and regulating the audit profession.

“The PCAOB is laser-focused on protecting investors,” said PCAOB spokesperson Jennifer Donohue when asked about the lawsuit.

Echoes of lawsuits past

The board has faced lawsuits in the past over its structure, including a case involving a small Nevada accounting firm, Beckstead & Watts, which was decided by the Supreme Court in 2010 with mixed results for the conservative group that filed suit.

The case, Free Enterprise Fund v. PCAOB, forced some changes in the governance of the PCAOB, and the NCLA referenced it in its lawsuit. In that case, the Supreme Court ruled that laws that allowed inferior officers to be insulated from the presidential removal authority with two levels of “for cause” removal violated Article Two of the Constitution. The court found the appointment provisions of Sarbanes-Oxley to be constitutional, but struck down the for-cause removal provision.

For right now, the NCLA is only seeking a hearing in the federal district court in Texas, but the case could have wider implications if it were to go to a higher court, especially with the increasingly conservative makeup of the Supreme Court.

“First and foremost, we just want to stop the proceeding as to our client that’s ongoing right now, but I think if the court were to do that, it would set a precedent that might have broader impact and encourage other people to make similar arguments,” Ryan told Accounting Today.

The case could have far-reaching implications as the overseer works to toughen enforcement in the audit profession. The complaint quotes a speech last month by PCAOB Chair Erica Williams at an AICPA conference.

“We intend to use every tool in our enforcement toolbox and impose significant sanctions, where appropriate, to ensure there are consequences for putting investors at risk and that bad actors are removed,” she said. “This includes substantial monetary penalties and significant or permanent individual bars and firm registration revocations. Those who break the rules — whether they are ethical rules or auditing rules — should know we won’t be constrained by the types of cases the [board] has pursued in the past. We won’t be limited to the level of penalties that have been seen before. And we will seek admissions of wrongdoing in appropriate cases — for example, where the conduct is intentional or egregious.”

The NCLA is raising constitutional issues that could constrain such efforts in the future.

“What we’re asking for is that the court order the PCAOB to stop its pending proceeding against our client and to declare that the process they’re using against him is unconstitutional,” said Ryan.

The complaint lays out a number of issues with the way the PCAOB selects and adjudicates cases. “It’s a broad-based objection to the way that the disciplinary process is handled at the PCAOB,” said Ryan. “We think there’s any number of constitutional problems with the case.”