Checkosky v. S.E.C.

Decision Date20 May 1994
Docket NumberNos. 92-1396,92-1214,92-5158,s. 92-1396
Parties, 62 USLW 2770, Fed. Sec. L. Rep. P 98,229, 29 Fed.R.Serv.3d 300 David J. CHECKOSKY, Norman A. Aldrich, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent, In re Application of David J. CHECKOSKY and Norman A. Aldrich for the Perpetuation of Certain Testimony and the Preservation of Other Evidence, In re David J. CHECKOSKY and Norman A. Aldrich, Petitioners.
CourtU.S. Court of Appeals — District of Columbia Circuit

Appeal from the United States District Court for the District of Columbia (92ms0103).

On Petition for a Writ of Mandamus.

Geoffrey F. Aronow, Washington, DC, argued the cause for petitioners. With him on the briefs was Andrew T. Karron, Washington, DC. Jay Kelly Wright and Samuel A. Thumma, Washington, DC, entered an appearance.

Susan Ferris Wyderko, Asst. General Counsel, S.E.C., Washington, DC, argued the cause for respondent. With her on the briefs were Paul Gonson, Sol., Richard M. Humes, Attorney, Paul P. Andrews, Sr. Counsel, and Richard H. Walker, Regional Adm'r, S.E.C., Washington, DC. Jeffrey R. Zuckerman and Henry Klehm, III, Attorneys, S.E.C., Washington, DC, entered an appearance in Nos. 92-5158 and 92-1214. James Robert Doty, Washington, DC, entered an appearance in No. 92-1396.

Kathryn A. Oberly, Washington, DC, was on the brief for amici curiae Arthur Andersen & Co.; Deloitte & Touche; Ernst & Young; and KPMG Peat Marwick.

Arthur F. Mathews and Michael R. Klein, Washington, DC, were on the brief for amicus curiae American Civil Liberties Union.

Before: SILBERMAN and RANDOLPH, Circuit Judges, and JOHN W. REYNOLDS, * District Judge.

Opinion PER CURIAM.

Circuit Judge SILBERMAN filed a separate opinion.

Circuit Judge RANDOLPH filed a separate opinion.

District Judge REYNOLDS filed a separate opinion, concurring in part and dissenting in part.

PER CURIAM:

The case is remanded to the Commission for a more adequate explanation of its interpretation of Rule 2(e)(1)(ii) and its application to this case. The court rejects unanimously, as per Part V of Judge Randolph's opinion, petitioners' challenge to the regularity of the Commission's proceedings.

So Ordered.

SILBERMAN, Circuit Judge:

The Commission suspended petitioners, partners in a national accounting firm, for "improper professional conduct" under Rule 2(e)(1)(ii). As I cannot determine from the order just what the Commission is using as its standard for improper professional conduct, I think the appropriate course is to remand (which we do) for the Commission to clarify its position before we substantively review the order. See Philadelphia Gas Works v. FERC, 989 F.2d 1246, 1251 (D.C.Cir.1993).

I.

Savin Corporation, a publicly traded company that for many years had successfully marketed photocopiers built by other companies, decided in the late 1970s to develop its own machines--a failed effort that gave rise to this case. Between 1977 and 1985, Savin contracted with an inventor to design a machine, employed over 500 employees in its Engineering and Manufacturing division, and built and tested a number of prototypes of the various designs for the elusive copier. Faced with the mounting costs of the endeavor, Savin in 1980 explored ways that it could defer its expenditures as a capitalized asset instead of declaring them as ordinary business expenses. Generally accepted accounting principles (GAAP), however, do not permit research and development costs to be deferred: "All research and development costs encompassed by this Statement shall be charged to expense when incurred." ACCOUNTING FOR RESEARCH AND DEVELOPMENT COSTS, Statement of Financial Accounting Standards No. 2, p 12 (Fin. Accounting Standards Bd.1974) [hereinafter FAS 2]. Savin in 1981 nevertheless formulated an accounting policy whereby it could define its expenditures related to the copier project not as research and development costs but rather as "start-up" costs, which the company believed could be "deferred and matched when normal production cycle is reached." Following the policy, the company deferred approximately $37 million from fiscal year (May 1 to April 30) 1981 to December 31, 1984.

David Checkosky was the engagement partner and Norman Aldrich was the audit manager for Coopers & Lybrand's audits of Savin's financial statements, which were all submitted to the Commission. Both consulted with Savin as the company developed its accounting policy's interpretation of FAS 2 that forms the core controversy of this case. Coopers & Lybrand, through Checkosky and Aldrich, issued audit reports for Savin's financial statements for fiscal years 1981 through 1983 which represented that the audits were conducted according to generally accepted auditing standards (GAAS) and which gave the auditors' unqualified opinion--i.e., without reservations--that the statements were presented in conformity with GAAP. The audit reports for fiscal year 1984 and the period between April 30 to December 31, 1984, contained the auditors' opinion that the financial statements conformed with GAAP subject to one qualification: that Savin's deferred start-up costs would eventually be recovered after successful manufacture and marketing of the copier. Savin abandoned its plans to develop a new copier in 1985, having never manufactured or marketed a single machine.

In 1987, the Commission initiated this disciplinary proceeding against Checkosky and Aldrich for "improper professional conduct" in violation of the Commission's Practice Rule 2(e), 17 C.F.R. Sec. 201.2(e)(1)(ii) (1993), with respect to their audits of Savin. 1 The Commission alleged that Checkosky and Aldrich had misrepresented that the financial statements were in conformity with GAAP when they certified that Savin has properly deferred its costs associated with the copier project. Moreover, Checkosky and Aldrich had violated GAAS by failing to exercise professional due care in planning and performing the audits and in preparing the audit reports. The administrative law judge agreed that the auditors had violated Rule 2(e)(1)(ii) and suspended them from practicing in front of the Commission for five years. Despite contrary arguments from Checkosky and Aldrich, the ALJ held that "improper professional conduct" within the meaning of the Rule does not require scienter; their violation of GAAP and GAAS alone suffices. After an independent review of the record, the Commission affirmed the ALJ's conclusion that the auditors had violated GAAP and GAAS and that scienter is not required to state a violation of Rule 2(e)(1)(ii)--and noted that the auditors' conduct "did in fact rise to the level of recklessness." The Commission concluded that the auditors' conduct warranted only a two-year suspension and reduced the ALJ's sanction accordingly.

Checkosky and Aldrich petition for review of the Commission's order, arguing that it had no statutory authority to promulgate Rule 2(e). They claim further that the Commission's order is not supported by substantial evidence and, in any event, that Rule 2(e)(1)(ii) could apply only to willful misconduct of the sort that would constitute scienter for substantive violation of the securities laws. Petitioners also argue that alleged procedural improprieties in the Commission's decisionmaking process deprived them of due process of law, a contention that we reject for the reasons stated in Part V of Judge Randolph's opinion which follows.

II.

Petitioners' general challenge to the Commission's authority to issue Rule 2(e) 2--entitled Suspension and Disbarment--has been addressed by two other courts, and I would add little to their well-crafted opinions. The Second Circuit in Touche Ross & Co. v. SEC, 609 F.2d 570 (2d. Cir.1979)--whose reasoning the Ninth Circuit adopted in Davy v. SEC, 792 F.2d 1418, 1421 (9th Cir.1986)--held that Rule 2(e) was validly promulgated under the Commission's " 'broad authority' to adopt those rules and regulations necessary for carrying out the agency's designated functions." Touche Ross, 609 F.2d at 580 (quoting Commercial Capital Corp. v. SEC, 360 F.2d 856, 857 (7th Cir.1966)). Inherent in this authority is the power to protect the integrity of the agency's administrative processes:

Although there is no express statutory provision authorizing the Commission to discipline professionals appearing before it, Rule 2(e), promulgated pursuant to its statutory rulemaking authority, represents an attempt by the Commission to protect the integrity of its own processes. It provides the Commission with the means to ensure that those professionals, on whom the Commission relies heavily in the performance of its statutory duties, perform their tasks diligently and with a reasonable degree of competence. As such the Rule is "reasonably related" to the purposes of the securities laws.

Touche, 609 F.2d at 582 (citing Mourning v. Family Publications Serv., Inc., 411 U.S. 356, 369, 93 S.Ct. 1652, 1660, 36 L.Ed.2d 318 (1973)).

The Second Circuit relied on the line of cases which held that administrative agencies have the power, under their general rulemaking authority, to prescribe standards of practice for attorneys practicing before them and to discipline those who fail to conform. See Goldsmith v. Board of Tax Appeals, 270 U.S. 117, 122, 46 S.Ct. 215, 217, 70 L.Ed. 494 (1926); Herman v. Dulles, 205 F.2d 715, 716 (D.C.Cir.1953). And we have since reaffirmed this principle: "There can be little doubt that the Commission, like any other institution in which lawyers or other professionals participate, has authority to police the behavior of practitioners before it." Polydoroff v. ICC, 773 F.2d 372, 374 (D.C.Cir.1985).

Importantly, the court in Touche clearly distinguished the Commission's authority to discipline professionals from its substantive enforcement...

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