After Jarkesy, Three Auditor Suits Test the PCAOB’s Enforcement Powers

The PCAOB is facing the most concerted attack in years on its enforcement powers through a trio of lawsuits that could test the reach of the Supreme Court’s Jarkesy ruling in audit industry oversight.

At stake in the three “John Doe” auditor challenges are the board’s core authorities under the Sarbanes-Oxley Act of 2002 to investigate and discipline public company auditors, coming at a time when the board is shattering previous records for monetary penalties.

The complaints each have a different set of underlying facts with clear common threads running through them. In each case, the plaintiff is an accountant or audit firm caught in some stage of the PCAOB investigative or disciplinary process, seeking to litigate under a John Doe pseudonym to avoid outing themselves as a PCAOB target; all three complaints invoke some similar constitutional arguments; and all are represented by teams that include the New Civil Liberties Alliance (NCLA), a legal group that has led successful challenges against the SEC and other regulators.

The complaints also face the same potential stumbling blocks. In all three cases, the PCAOB has sought dismiss or transfer the challenges to its home venue in U.S. District Court for the District of Columbia (D.D.C.). And it is asking judges to deny the shield of “John Doe” pseudonymity, arguing the auditors should litigate using their real names, or not at all. In both areas, the board has met with some success.

Perhaps most importantly, all three challenges are moving forward under the shadow of this summer’s ruling in SEC v. Jarkesy, in which the High Court held that defendants in SEC fraud actions involving monetary penalties have a right to a jury trial. That ruling, which hinged on the Seventh Amendment, left a host of open questions surrounding the viability of entities such as the PCAOB to assign penalties via an in-house process.

The Seventh Amendment claim “is among our strongest claims,” said Russ Ryan, NCLA senior litigation counsel and a former assistant director at the SEC Division of Enforcement. “And I think Jarkesy is, if not controlling, it’s pretty close to it.”

The litigation is likely to continue into a new year under the successor to SEC Chair Gary Gensler, whose announced departure coincides with the upcoming presidential inauguration. President-elect Donald Trump has said he will nominate former commissioner Paul Atkins, a PCAOB critic who has attacked the board’s expanding budget and spoken favorably of the idea of consolidating the board with the SEC.

The Republican-led commission is expected to then name its own replacement for current PCAOB Chair Erica Williams and potentially other board members, who could easily take a different view of audit industry enforcement than the current board.

The PCAOB last year notched more than $20 million in penalties, the largest total in its history, following a record total the year before. It has already surpassed that record this year with about $35 million in penalties imposed, $25 million of which came under a single enforcement action against KPMG Netherlands in April, the largest in the board’s history.

The PCAOB imposed monetary penalties on respondents in more than 95% of actions it launched in the first half of the year, according to an August report from The Brattle Group.

“I expect to see lower levels of enforcement activity and significantly lower penalties in the next few years, based on the combination of the incoming new administration and the constitutional challenges to the PCAOB’s enforcement authority,” said Alison Forman, principal at The Brattle Group.

Should the PCAOB lose its ability to impose penalties, she predicted the board may focus on other sanctions such as barring individuals from practicing or revoking a firm’s registration “which can be much more consequential than a monetary penalty, particularly for individual auditors and for smaller firms.”

The cases are:

• John Doe v. PCAOB, filed in January 2023 in the Northern District of Texas and transferred to D.D.C. in March of this year. The plaintiff is described as an accountant who previously worked as an auditor for a firm in Colombia that is part of a global network. The PCAOB launched a disciplinary action against him in 2022 tied to an alleged failure to cooperate with a board inspection and investigation of a component audit related to a public company’s 2015 financial statements.
• John Doe v. PCAOB, filed in March 2024 in the Middle District of Tennessee. The plaintiff is a Tennessee accountant subject to PCAOB proceedings launched in September 2023. Unlike the other cases, here Chair Williams and the rest of the board are named as defendants alongside the PCAOB itself. The board is seeking to have the complaint dismissed or transferred to D.D.C.
• John Doe Corp. v. PCAOB, filed March 2024 in the Southern District of Texas. The plaintiff is a Texas audit firm subject to a board investigation tied to its auditing of crypto assets. Unlike in the other two complaints, the PCAOB has not launched formal disciplinary proceedings. Instead, the complaint hinges on the constitutionality of an accounting board demand (ABD) issued by the board.The case was transferred to D.D.C. in August. The 5th U.S. Circuit Court of Appeals in October directed the Southern District of Texas to request the case be transferred back, at least temporarily, finding the district court failed to follow its own standing order requiring a 21-day stay in out-of-circuit transfers. D.D.C. on November 19 returned the case to its original venue.

  The audit firm on November 26 asked the 5th Circuit to void the August transfer order to D.D.C., calling it “erroneous and premature.”

Jarkesy

The Jarkesy opinion, authored by Chief Justice John Roberts, represented the latest in a string of Supreme Court setbacks for the commission in recent years. The High Court essentially foreclosed on contested fraud proceedings before an SEC administrative law judge (ALJ) where penalties are at stake, cementing a shift away from litigated in-house proceedings the agency began in earnest six years ago following another ALJ-focused Supreme Court ruling in Lucia v SEC.

The ruling set off a wave of speculation on the broader implications for administrative enforcement, including at the PCAOB. The board is a nonprofit corporation established under Sarbanes-Oxley to oversee public company auditors, and is not itself a federal agency, although its rules and budget are subject to SEC approval. The board is considered part of the government for constitutional purposes.

A key post-Jarkesy question is whether courts narrowly interpret the ruling, or if they find parallels in other administrative enforcement regimes and the sanctions available to them. Critics of the PCAOB see a clear resemblance to SEC ALJs in the board’s own hearing officers.

“The PCAOB hearing process was set out to largely mimic the SEC’s process, and so the hearing officer is essentially a carbon copy of the SEC ALJs,” Ryan said. “And just like the SEC system, the PCAOB system is not an Article III court, and it does not have any mechanism to impanel a jury. My reading of Jarkesy says that both of those problems are violations of the Seventh Amendment.”

Article III is the provision of the US Constitution establishing and empowering the federal judiciary.

The Seventh Amendment sets out that “in suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved.”

The Jarkesy court found SEC penalties to be “legal” in nature – designed to punish or deter the wrongdoer – rather than “equitable” relief meant to compensate victims or restore the status quo. The High Court, which found a close relationship with federal securities fraud and common law fraud, concluded that SEC civil penalties can only be enforced in federal court.

Many of the claims the PCAOB brings also resemble common law claims, said Michael Dell, a partner with Kramer Levin Naftalis & Frankel LLP.

“The argument that the claims are legal in nature applies to most of the proceedings that the PCAOB might bring, because those proceedings are designed to punish or deter the wrongdoer, not to compensate others for injuries they may have suffered,” he said.

Two of the three Doe plaintiffs filed amended complaints in August to, among other changes, update their arguments in light of Jarkesy.

In the Tennessee case, the accountant argues that because PCAOB disciplinary proceedings “are not decided in an Article III court and systematically deprive respondents of their right to trial by jury, they are unconstitutional,” citing Jarkesy.

In the John Doe Corp matter, the firm is taking aim at the lack of Article III judicial review prior to PCAOB compelling testimony and document production. It argues, among other points, that a lack of venue or mechanism to challenge the PCAOB’s investigative demand implicates its Seventh Amendment jury trial right, “as made clear” by the Supreme Court ruling.

In a September motion to dismiss in that latter case, the PCAOB argued that Doe lacks standing to raise a Seventh Amendment claim, and that the “boilerplate penalties language” of an ABD does not create an imminent enforcement threat or say the board will necessarily impose sanctions. The claim, the board argued, “depends on a chain of future contingencies that might never occur.”

The PCAOB asserted: “To be clear, the Board does not concede that any of the sanctions it might impose would implicate the Seventh Amendment issues under Jarkesy.”

For the purpose of determining Doe Corp.’s standing, it argued that some noncooperation sanctions such as suspension or revocation of registration, “are indisputably equitable in nature and therefore would not raise any Seventh Amendment concern.”

It argued that “pre-enforcement review of an ABD could result only in an equitable remedy—akin to an injunction,” concluding the plaintiff therefore has no right to a jury trial in connection with pre-enforcement review of the investigative demand.

John Doe Corp. fired back in a brief that attacked as “absurd” the PCAOB’s assertion that relief such as revoking or suspending a firm’s registration is equitable and not legal in nature, since such sanctions are also designed at least in part to punish and deter.

Venue and Pseudonymity

The PCAOB wants all three cases brought to D.D.C., where it has several distinct advantages. For one, it is far from the 5th Circuit, the conservative appeals court covering Texas, Mississippi, and Louisiana that ruled two years ago against the SEC in Jarkesy. D.D.C. is the home venue for the D.C.-based board, adding a headache for plaintiffs based in Tennessee and Texas.

And in D.D.C., Chief Judge James Boasberg has taken a dim view the of moving the cases forward under John Doe pseudonymity, ruling in early August that the Colombia-based auditor “has not met his burden to show that his privacy interests outweigh the public’s presumptive and substantial interest in learning his identity.” That ruling has been appealed to the District of Columbia U.S. Circuit Court of Appeals.

The denial of pseudonymity would create a significant obstacle in all three cases and force the auditors to decide between dropping their suits or naming themselves as the targets of PCAOB disciplinary action or investigation, a tough prospect in a reputation-centric industry.

For much the same reasons, Sarbanes-Oxley sets out that ongoing PCAOB disciplinary proceedings must take place behind closed doors unless all parties agree to make them public. The auditors have argued that those same protections should be mirrored in their constitutional challenges to the PCAOB’s authority; Judge Boasberg has signaled he disagrees.

Venue, as well, remains in flux. Thus far, one case remains in Tennessee, one has been successfully transferred from Texas to D.C., and the third – John Doe Corp. – remains in a state the PCAOB has criticized as “jurisdictional ping-pong.”

“We very much view this case still as a case within the 5th Circuit,” said Jacob Frenkel, chair of Government Investigations & Securities Enforcement at Dickinson Wright PLLC, which is representing John Doe Corp. alongside the NCLA.

On pseudonymity, he said the different procedural state of his case – being at the investigative level and not subject to a disciplinary action – could benefit their argument for moving forward as a John Doe plaintiff.

“Not only is the Doe Corp. case in a different procedural state, it’s one that whether this was the SEC, the PCAOB, or even in a grand jury, is recognized to be a confidential posture,” he said.

Remaining in the Fifth Circuit could also benefit some of the non-Seventh Amendment claims in the John Doe Corp. complaint.

The Fifth Circuit’s 2022 Jarkesy ruling was significantly broader than narrow jury trial question that the Supreme Court focused on. Judge Jennifer Walker Elrod held SEC ALJs to be unconstitutional for two other reasons: Congress, she concluded, did not spell out an “intelligible principle” when delegating the authority to the SEC to choose whether it brings cases before its own ALJs or in federal court; and restrictions on removing an ALJ violate the provision in Article II of the Constitution requiring the president to “take care that the laws be faithfully executed.” The Supreme Court majority found the jury trial question resolved the case, and did not reach the nondelegation and ALJ removal questions.

Those two questions, however, are both mirrored in the Doe complaints.

In the John Doe Corp matter, the plaintiff argues that Sarbanes-Oxley failed to define “fair procedures” for investigating and disciplining audit firms and gave no intelligible principle to guide the board’s resulting rules.

The other two cases, meanwhile, attack the “multi-layered tenure protections” of PCAOB hearings under Article II, citing the Fifth Circuit Jarkesy opinion.

The Department of Justice has intervened in all three cases to defend the constitutionality of the challenged Sarbanes-Oxley provisions.

Editor’s note: This story was updated to reflect President-elect Donald Trump’s announcement he would nominate Atkins as the next SEC chair, which took place after this story was originally published.