Kpmg, Llp v. S.E.C., No. 01-1131.

CourtUnited States Courts of Appeals. United States Court of Appeals (District of Columbia)
Writing for the CourtRogers
Citation289 F.3d 109
PartiesKPMG, LLP, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
Decision Date14 May 2002
Docket NumberNo. 01-1131.
289 F.3d 109
KPMG, LLP, Petitioner,
v.
SECURITIES AND EXCHANGE COMMISSION, Respondent.
No. 01-1131.
United States Court of Appeals, District of Columbia Circuit.
Argued February 15, 2002.
Decided May 14, 2002.
Rehearing and Rehearing En Banc Denied July 16, 2002.

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COPYRIGHT MATERIAL OMITTED

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

Michael P. Carroll argued the cause for petitioner. With him on the brief were Ronald S. Flagg and Joseph R. Guerra.

Louis A. Craco, Jr. argued the cause and filed the brief for amicus curiae American

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Institute of Certified Public Accountants in support of petitioner.

Rada Lynn Potts, Senior Litigation Counsel, Securities and Exchange Commission, argued the cause for respondent. With her on the brief were David M. Becker, General Counsel, Jacob H. Stillman, Solicitor, and Michael A. Conley, Attorney.

Before: HENDERSON, RANDOLPH and ROGERS, Circuit Judges.

Opinion for the Court filed by Circuit Judge ROGERS.

Dissenting opinion filed by Circuit Judge RANDOLPH.

ROGERS, Circuit Judge:


KPMG, LLP (formerly KPMG Peat Markwick, LLP) challenges a cease-and-desist order entered by the Securities and Exchange Commission, pursuant to Section 21C(a) of the Securities Exchange Act ("Exchange Act"), 15 U.S.C. § 78u-3(a), on the basis of several violations of the securities laws and regulations. KPMG principally contends that the Commission lacks authority to turn the ancillary authority provided by Section 21C into an independent basis to sanction accountants, failed to give fair notice of its novel interpretation of Rule 302 of the Code of Professional Conduct of the American Institute of Certified Public Accountants ("AICPA"), and adopted an improper presumption in concluding there was a sufficient risk of future violations warranting a cease-and-desist remedy. KPMG also contends that the cease-and-desist order is overbroad and vague. We hold that although KPMG did not have fair notice of the Commission's interpretation of AICPA Rule 302, the Commission properly could use a negligence standard to enforce violations of the Exchange Act and Commission rules under Section 21C. We also hold that several contentions are waived, not having been raised before the Commission. We further hold that, although the Commission's explanation on reconsideration of the basis for its conclusion that there was a risk of future harm might leave ambiguous whether simply one or more than one of the violations would be sufficient to meet its standard for entry of a cease-and-desist order, there is no ambiguity here that the Commission on remand would reach the same result. Accordingly, we deny the petition for review.

I.

The Commission issued the cease-and-desist order following an evidentiary hearing that commenced, based on allegations by the Division of Enforcement and the Office of the Chief Accountant (together, "the Division"), with the issuance on December 4, 1997, of an order instituting a proceeding ("OIP") under Commission Rule of Practice 102(e) and Section 21C of the Exchange Act. The evidentiary hearing was to determine if KPMG had engaged in improper professional conduct violated Rule 2-02 of Regulation S-X and caused violations of Section 13(a) of the Act and Rule 13a-1 thereunder, and if so, what remedial actions or sanctions would be appropriate. The evidence at the hearing revealed the following:

In January 1995, as part of an effort to start a separate entity that would provide financial and business consulting services to clients, KPMG (then known as KPMG Peat Marwick) entered into a license agreement with KPMG BayMark, LLC ("BayMark"), and BayMark subsidiaries known as KPMG BayMark Strategies ("Strategies"), and KPMG BayMark Capital. Under its license agreement, KPMG agreed to lend $100,000 to each of the four founding principals to be used by them as equity contributions to BayMark and its

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subsidiaries. Also under the agreement, KPMG granted BayMark rights to use "KPMG" as part of its name in return for a royalty fee of five percent of its quarterly consolidated fee income.

Glenn Perry, a senior partner in KPMG's Department of Professional Practice ("DPP") had previously met with Commission staff from the Office of the Chief Accountant ("OCA") to discuss independence issues surrounding the BayMark arrangement, and when OCA became aware that KPMG was moving forward with the plan, OCA staff asked KPMG for additional information. On October 19, 1995, Perry and a KPMG senior manager named Chris Trattou met with OCA staff. The meeting concluded with OCA staff cautioning KPMG against having BayMark provide services to any of the audit clients of KPMG. Notwithstanding this warning, on November 3, 1995, Strategies entered into an agreement with PORTA — a long-standing KPMG audit client facing financial difficulties — to provide "turnaround services" and assist it with financing. Leonard Sturm, KPMG's engagement partner for PORTA's 1994 audit, had introduced PORTA to BayMark. Under the agreement between PORTA and Strategies, one of BayMark's founding principals, Edward Olson, would be Chief Operating Officer of PORTA and Strategies would receive a management fee of $250,000 and a "success fee" based on a percentage of PORTA's earnings, disposed inventory, and restructured debt. On November 9, 1995, PORTA's Board of Directors elected Olson president and Chief Operating Officer of the company.

Sturm became aware that PORTA was engaging BayMark and contacted the DPP to determine whether it was okay for BayMark to provide services to an audit client. Trattou indicated that it was okay and that the Commission had no objection to it. Once Sturm learned that Olson was an officer of PORTA, he inquired again as to whether there were any independence concerns with the audit. Trattou discussed the matter with Michael Conway, the partner in charge of the DPP; they disagreed as to the propriety of the arrangement, with Conway (and Perry) expressing concern.

After several meetings in December 1995 between Conway and Perry and OCA staff, OCA staff indicated that in order to resolve its independence concerns, KPMG would need to drop the KPMG initials from the BayMark parties' names, eliminate the royalty fee arrangement, and bring about the repayment of the $400,000 in loans made to the BayMark principals. Conway agreed to undertake negotiations with BayMark to make these changes. Although Conway alerted OCA staff to the existence of six dual engagements where KPMG was the auditor of record and BayMark had contracts with those clients, Conway did not inform OCA staff of the detailed entanglements involved with PORTA, i.e., the outstanding loan to Olson, Olson's status as an officer of PORTA and a principal of BayMark, and the success fee arrangement.

The evidence also showed that sometime before December 27, 1995, Trattou called Sturm with an answer to Sturm's earlier independence inquiries. Trattou indicated that the Commission was aware of the PORTA situation and that the KPMG audit of PORTA could proceed. On December 27, 1995, PORTA signed KPMG's engagement letter to conduct its 1995 audit. When OCA staff discovered the PORTA audit, it informed Conway that KPMG was not independent from PORTA because none of the structural changes to the BayMark strategic alliance had been implemented and a loan was outstanding to Olson who was part of PORTA's management.

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By letter of June 21, 1996, OCA advised PORTA that KPMG's independence had been compromised and that PORTA's audited financial statements included in its 1995 annual report would be considered unaudited and not in compliance with federal securities laws.

In light of this evidence, an administrative law judge ("ALJ") found that under Generally Accepted Auditing Standards ("GAAS"), KPMG lacked independence from PORTA by virtue of its loan to Olson and that as a result, KPMG engaged in and caused violations charged in the OIP but did not engage in improper professional conduct under Rule 102(e) because KPMG did not act recklessly. See Matter of KPMG Peat Marwick L.L.P., 71 S.E.C. Dkt. 1220, 2000 WL 45725, at *32-33 (Jan. 21, 2000). In determining a remedy, the ALJ considered the factors identified by the Commission as relevant to determining whether to issue an injunction: egregiousness of the defendant's action, isolated or recurrent nature of the infraction, degree of scienter involved, sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that his occupation will present opportunities for future violations. See id. at *34 (citing Matter of Joseph J. Barbato, 69 S.E.C. Dkt. 179, 200 n.31, 1999 WL 58922 (Feb. 10, 1999) (quoting Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir.1979), aff'd on other grounds, 450 U.S. 91, 101 S.Ct. 999, 67 L.Ed.2d 69 (1981))). The ALJ declined to issue a cease-and-desist order. The ALJ considered it significant that the audit itself was not challenged (and a second audit reached the same result), that the violations were not recurring, growing out of "highly unusual circumstances," and that there was no evidence of an adverse impact on investors. See id. at *34. The Division appealed the decision to the Commission.

The Commission conducted "an independent review of the record." Order at 3. It concluded, on the basis of KPMG's debtor/creditor relationship with Olson and its right to share in Strategies' "success" fee, that KPMG's independence was impaired under GAAS. Noting that KPMG admitted that the loan to Olson impaired its independence under GAAS, the Commission characterized the violation as a "serious" mistake that arose from KPMG's failure to exercise ordinary care to maintain its independence. Further, the Commission interpreted AICPA Rule 302 to "flatly prohibit[] an auditor from `perfor[ming] for a contingent fee any...

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19 practice notes
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    • July 9, 2008
    ...v. N.L.R.B., 483 F.3d 628 (9th Cir.2007) (action for judicial review of an N.L.R.B. order under 29 U.S.C. § 160(f)); KPMG, LLP v. S.E.C., 289 F.3d 109 (D.C.Cir.2002) (action for judicial review of a decision of the S.E.C. under 15 U.S.C. § 78y); 5 U.S.C. § 7703 (in a provision regarding "[j......
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    ...certain than the rule at issue in U.S. Telecom , little would follow from that premise.The D.C. Circuit's decisions in KPMG, LLP v. SEC , 289 F.3d 109 (D.C. Cir. 2002), and United States ex rel. Purcell v. MWI Corp. , 807 F.3d 281 (D.C. Cir. 2015), are no more helpful to NAFA's position. In......
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    • United States Courts of Appeals. United States Court of Appeals (District of Columbia)
    • July 30, 2004
    ...to an act or omission the person knew or should have known would contribute to such violation...." Although we held in KPMG, LLP v. SEC, 289 F.3d 109, 120 (D.C.Cir.2002), that the "knew or should have known" language in § 21C embodied a negligence standard for purposes of that case, it does......
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    • United States Courts of Appeals. United States Court of Appeals (9th Circuit)
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    ...v. N.L.R.B., 483 F.3d 628 (9th Cir.2007) (action for judicial review of an N.L.R.B. order under 29 U.S.C. § 160(f)); KPMG, LLP v. S.E.C., 289 F.3d 109 (D.C.Cir.2002) (action for judicial review of a decision of the S.E.C. under 15 U.S.C. § 78y); 5 U.S.C. § 7703 (in a provision regarding "[j......
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    • April 30, 2013
    ...to the TotalView Proposal before the Commission and we therefore lack jurisdiction to review that petition. See KPMG, LLP v. SEC, 289 F.3d 109, 117 (D.C.Cir.2002) (Exchange Act section 25(c)(1)'s administrative exhaustion requirement is jurisdictional). The petitioners counter that we have ......
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    ...certain than the rule at issue in U.S. Telecom , little would follow from that premise.The D.C. Circuit's decisions in KPMG, LLP v. SEC , 289 F.3d 109 (D.C. Cir. 2002), and United States ex rel. Purcell v. MWI Corp. , 807 F.3d 281 (D.C. Cir. 2015), are no more helpful to NAFA's position. In......
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    • July 30, 2004
    ...to an act or omission the person knew or should have known would contribute to such violation...." Although we held in KPMG, LLP v. SEC, 289 F.3d 109, 120 (D.C.Cir.2002), that the "knew or should have known" language in § 21C embodied a negligence standard for purposes of that case, it does......
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