Checkosky v. S.E.C., 97-1137

• Decision Date: 27 March 1998
• Docket Number: No. 97-1137,97-1137
• Citation: 139 F.3d 221
• Parties: , Fed. Sec. L. Rep. P 90,299 David J. CHECKOSKY and Norman A. Aldrich, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 221

139 F.3d 221

329 U.S.App.D.C. 184, Fed. Sec. L. Rep. P 90,299

David J. CHECKOSKY and Norman A. Aldrich, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 97-1137.

United States Court of Appeals District of Columbia Circuit.

Argued Feb. 18, 1998.

Decided March 27, 1998.

On Petition for Review of an Order of the Securities and Exchange Commission.

Andrew T. Karron, Washington, DC, argued the cause for petitioners. With him on the briefs was Jay Kelly Wright.

Richard M. Humes, Associate General Counsel, Securities & Exchange Commission, argued the cause for respondent. With him on the brief were Richard H. Walker, General Counsel, Susan A. Yashar, Assistant General Counsel, and Paul Gonson, Solicitor, Washington, DC. Susan F. Wyderko, Counsel, entered an appearance.

Before: EDWARDS, Chief Judge, WILLIAMS and HENDERSON, Circuit Judges.

Opinion for the Court filed by Circuit Judge WILLLIAMS.

Concurring opinion filed by Circuit Judge HENDERSON.

WILLIAMS, Circuit Judge:

Six years ago the Securities and Exchange Commission found that two accountants had engaged in "improper professional conduct" in violation of the Commission's Rule 2(e)(1)(ii), 17 C.F.R. § 201.102(e)(1)(ii). After review in this court we remanded the case to the Commission, holding that it had failed to adequately explain its interpretation of the rule. Checkosky v. SEC, 23 F.3d 452, 454 (D.C.Cir.1994) ("Checkosky I "). The Commission has evidently been unable to do so, voicing instead a multiplicity of inconsistent interpretations. In view of the Commission's inability to make any progress toward offering a single interpretation, and signs that the Commission is unlikely soon to make such progress, we are driven to the remedy reserved for rare cases of an agency's persistent failure to explain itself, and remand the case with instructions to dismiss the proceedings. See Greyhound Corp. v. ICC, 668 F.2d 1354 (D.C.Cir.1981).

* * *

Because the facts are recounted at length in the separate opinions of Judges Silberman and Randolph in Checkosky I, we supply only a brief summary. In the first half of the 1980s petitioners David Checkosky and Norman Aldrich, accountants at Coopers & Lybrand, performed a series of audits on behalf of Savin Corporation, a publicly traded company in the photocopier marketing business. During the years for which the audits were performed, Savin was trying (ultimately without success) to branch out into manufacturing by developing its own photocopier. Under generally accepted accounting principles ("GAAP"), costs of research and development must be expensed immediately rather than deferred. See Accounting For Research and Development Costs, Statement of Financial Accounting Standards No. 2, p 12 (Fin. Accounting Standards Bd.1974). But once R&D is complete, a company may defer so-called "start-up" costs, see id. at p 10, treating them as a capital item, presumably to be depreciated in due course. After consulting with Checkosky, Savin decided to defer the escalating costs of its design effort by categorizing them as start-up costs. The Commission later found that in financial statements filed with it for periods between May 1, 1980, and December 31, 1984, Savin improperly deferred $37 million in research and development costs in this fashion. In all cases Checkosky and Aldrich had reported that Savin's statements conformed with GAAP and that their own audits had been conducted according to generally accepted auditing standards ("GAAS").

The Commission initiated disciplinary proceedings against Checkosky and Aldrich in 1987, charging that the two accountants had engaged in "improper professional conduct" in violation of Rule 2(e)(1)(ii). ¹ An administrative law judge suspended them for five years from "practicing before the Commission," a broad term that encompasses preparation of any document for filing with the Commission. ² In 1992 the Commission affirmed the ALJ's finding that Checkosky and Aldrich had failed to observe GAAS and had improperly represented that Savin's financial statements complied with GAAP. In re David J. Checkosky & Norman A. Aldrich, 50 S.E.C. 1180 (1992). The Commission stated that "a mental awareness greater than negligence is not required" to state a violation of Rule 2(e)(1)(ii), but "note[d]," as if in passing, that Checkosky and Aldrich's conduct "did in fact rise to the level of recklessness." Id. at 1197. The Commission thus affirmed the ALJ's finding that Checkosky and Aldrich violated Rule 2(e)(1)(ii). It reduced their suspension, however, from five years to two. Petitioners petitioned for review in this court on several grounds and we remanded to the Commission, holding that it had failed to adequately explain its interpretation and application of Rule 2(e)(1)(ii). Checkosky I, 23 F.3d at 454.

On January 21, 1997 the Commission issued an opinion on remand affirming the suspensions. In re David J. Checkosky & Norman A. Aldrich, 7 Fed.Sec.L.Rep. (CCH) p 74,386, at 63,421 (Jan. 21, 1997) ("1997 Op."). Checkosky and Aldrich again petitioned for review in this court, again claiming (among many other things) that the Commission had failed to articulate an intelligible standard for "improper professional conduct" under Rule 2(e)(1)(ii). Because we agree with this claim, we do not address the others.

* * *

In something of a tour de force, the Commission's 1997 opinion manages to both embrace and reject standards of (1) recklessness, (2) negligence and (3) strict liability--or so a careful (and intrepid) reader could find. It first appears to rely on a theory of recklessness. After a relatively brief survey of the facts, the opinion says: "We previously found that [Checkosky and Aldrich] engaged in improper professional conduct and that their conduct was reckless. We begin by explaining our reasons for this conclusion and why we continue to find their conduct reckless." 1997 Op. at 63,426. ³ But after devoting several pages to an attempt to demonstrate petitioners' recklessness, the opinion abruptly forswears any reliance on that concept as an element of improper professional conduct under Rule 2(e)(1)(ii): "We believe that Rule 2(e)(1)(ii) does not mandate a particular mental state and that negligent actions by a professional may, under certain circumstances, constitute improper professional conduct." Id. at 63,430.

On review the Commission adhered to the second of these positions, disavowing any suggestion that recklessness is necessary for a violation of Rule 2(e)(1)(ii). At oral argument it likewise disclaimed reliance on recklessness as a standard for the substantive violation, see Transcript at 26-27, and hewed to the line adopted in its brief, treating recklessness as relevant only to the choice of sanction: "Only after concluding that petitioners had engaged in improper professional conduct did the Commission consider petitioners' mental state to determine whether to impose a sanction." Brief for Respondent at 49. Thus, although in fact the 1997 opinion began with a consideration of petitioners' mental state, the Commission's present position confirms that recklessness was not an element of its substantive charge.

With recklessness out of the picture, negligence would seem to be the most obvious remaining candidate. But the 1997 opinion failed to adopt an intelligible negligence standard. Instead, as we have already noted, it said only, "We believe that Rule 2(e)(1)(ii) does not mandate a particular mental state and that negligent actions by a professional may, under certain circumstances, constitute improper professional conduct." 1997 Op. at 63,430 (emphasis added). Elementary administrative law norms of fair notice and reasoned decisionmaking demand that the Commission define those circumstances with some degree of specificity. It has not done so.

The only further definition the Commission offered was its observation that negligent deviations from GAAS or GAAP will be held to violate Rule 2(e)(1)(ii) when they threaten the integrity of the Commission's processes. See, e.g., 1997 Op. at 63,429 ("Our conclusions about the propriety of particular professional conduct are driven by the impact on Commission processes of the specific facts presented in a given proceeding before us."). This is fine as an identification of one of the main underlying purposes of Rule 2(e), ⁴ but not as a standard for determining violations of the rule in disciplinary proceedings. Accountants and attorneys practicing in the securities field will draw little comfort from the knowledge that their missteps will escape sanction as long as they do not "threaten the integrity of the Commission's processes." It is simply impossible to know in advance what sorts of negligent errors will meet this "standard"; we can imagine both narrow and potentially all-embracing constructions.

Finally, the Commission's opinion leaves open the possibility that a "standard" revolving around perceived danger to future processes might not even require a showing of negligence:

We wish to make clear, however, that the fact that GAAP and GAAS are professional standards against which we examine the conduct of accountants does not mean that every deviation from GAAP or GAAS is improper professional conduct warranting discipline under Rule 2(e)(1)(ii). Our processes are not necessarily threatened by innocent or even certain careless mistakes. At times, we have found improper professional conduct by accountants who engage in several deviations of [sic] GAAS or GAAP, or who deviated from GAAS or GAAP in more than one audit, or with more than one client. However, isolated failures may be so serious as to warrant discipline.

Id. at 63,432 (footnotes omitted). In the space of four short sentences this passage achieves impressive feats of ambiguity. The first sentence does not clearly rule out the possibility that non-negligent deviations from GAAS and GAAP could violate Rule 2(e)(1)(ii). The second...