63FR57163 Amendment to Rule 102(e) of the Commission's Rules of Practice, Part 2/4
robop...@us.govnews.org
Posting-number: Volume 63, Issue 206, Page 57163, Part 1
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IV. Summary of Regulatory Flexibility Analysis
A summary of the Initial Regulatory Flexibility Analysis (``IRFA'')
on the proposed amendment to Rule 102(e) was published in the proposing
release. The IRFA indicated that the proposed amendment would clarify
the standard by which the Commission determines whether accountants
have engaged in ``improper professional conduct.'' No comments were
received on the IRFA. The Commission has prepared a Final Regulatory
Flexibility Analysis (``FRFA'') in accordance with 5 U.S.C. 604 on the
amendment to Rule 102(e). The following summarizes the FRFA.
The FRFA discusses the need for the rule amendment. Rule 102(e)
currently authorizes the Commission to censure an accountant or deny,
temporarily or permanently, an accountant's privilege of appearing or
practicing before the Commission, if the accountant lacks character or
integrity, or has engaged in unethical or ``improper professional
conduct.'' The existing rule does not define ``improper professional
conduct.''
In a recent opinion addressing the conduct of two accountants, the
U.S. Court of Appeals for the District of Columbia Circuit found that
the Commission's opinions in the case had not articulated clearly the
``improper professional conduct'' element of the Rule. To address the
court's concerns, the Commission is clarifying the Commission's
standard for determining when accountants engage in ``improper
professional conduct.''
The FRFA explains that the rule amendment is designed to protect
the integrity of the Commission's processes. By clarifying the
standards applied in determining ``improper professional conduct,'' the
amendment will help the Commission, its administrative law judges, and
the courts apply the rule fairly and consistently. The amendment will
also give practitioners additional guidance about the standards for
proceedings under Rule 102(e).
The FRFA explains that the notice of proposed rulemaking indicated
how a copy of the IRFA could be obtained, and that no one requested a
copy of the IRFA. The IRFA, and the summary of the IRFA that appeared
in the notice of proposed rulemaking, also solicited comments
generally, and in particular on the number of small entities that would
be affected by the proposed amendment and the existence or nature of
the effect. No commenters discussed either the IRFA generally or the
number of small entities that would be affected by the proposed
amendment.
The FRFA also discusses the effect of the amendment on small
entities. The FRFA states that approximately 1000 accounting firms can
or do appear or practice before the Commission. While most of this
practice is conducted by the ``Big Five'' firms, which are not small
entities, many smaller firms do practice before the Commission. The
Commission does not, however, collect information about revenues of
accounting firms, which information generally is not made public by the
[[Page 57171]]
firms, and therefore cannot determine how many of these are small
entities for purposes of the analysis. In any event, the proposed
amendment should have little or no impact on small entities because the
proposal simply clarifies the Commission's standard for determining
when accountants engage in ``improper professional conduct.'' The
Commission's standard provides a remedy for certain violations of the
accountants' own professional standards and does not impose any new
standards of conduct.
The FRFA notes that the amendment would not impose any new
reporting, recordkeeping or compliance requirements. The FRFA discusses
the various alternatives considered to minimize the effect on small
entities, including: (a) The establishment of differing compliance or
reporting requirements or timetables that take into account the
resources of small entities; (b) the clarification, consolidation or
simplification of compliance and reporting requirements under the Rule
for small entities; (c) the use of performance rather than design
standards; and (d) an exemption from coverage of the Rule, or any part
thereof, for small entities. The Commission believes it would be
inconsistent with the purposes of the Rule to exempt small entities
from the proposed amendment. Different compliance or reporting
requirements for small entities are not necessary because the proposed
amendment does not establish any new reporting, recordkeeping or
compliance requirements. The proposed amendment is already designed to
clarify the current standard employed in Rule 102(e)(1)(ii), and the
Commission does not believe it is feasible to further clarify,
consolidate or simplify the Rule for small entities. Finally, the
proposal does use a performance standard, not a design standard, to
specify what conduct is expected of accountants; the Commission does
not believe different performance standards for small entities would be
consistent with the purposes of the Rule.
The FRFA notes that two commenters suggested that the proposed rule
could have an adverse effect on small accounting firms and/or small
public companies. The Commission believes that it has addressed the
concern that a simple negligence standard might raise fees or
discourage auditors from practice by raising the standard in the final
amendment. Finally, the FRFA notes that one commenter contended that
the proposed amendment would not impose a disproportionate impact on
small entities, and that another commenter wrote that the level of
competence expected of a professional must be an absolute standard,
regardless of the entity's size.
A copy of the FRFA may be obtained by contacting David R.
Fredrickson, Office of the General Counsel, Securities and Exchange
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
V. Cost-Benefit Analysis
The Commission requested comments on any costs or benefits
associated with the proposed amendment. No commenters offered any
specific cost or benefit estimates. Several commenters, however,
discussed the costs and benefits of the proposed amendment in general
terms.
One commenter suggested that the ``costs associated with the
proposed amendment appear to outweigh its potential benefits,'' \75\
but offered no data to support the view. The commenter did describe the
costs of the proposed amendment as ``costs associated with a decisional
standard that fails to provide professionals with adequate notice of
the conduct which could be subject to sanction,'' and costs created by
the ``exposure of auditors to sanction based on a single negligent
mistake,'' which the commenter believed ``would introduce an overly
conservative bias into the financial reporting process.'' \76\
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\75\ See AICPA Comment Letter, at 30.
\76\ Id. at 30-31.
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This commenter's concern that the proposed rule's use of a simple
negligence standard would impose costs was shared by other commenters.
Three commenters suggested that adoption of a simple negligence
standard would, among other things, cause audit fees to increase.\77\
Likewise, one of these commenters and one other commenter suggested
that the proposed rule's use of a negligence standard would discourage
competent practitioners from pursuing careers in public company
auditing.\78\
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\77\ See Comment Letter of R. Fogg (Aug. 12, 1998); Comment
Letter of James Backus (Aug. 13, 1998) (``Backus Comment Letter'');
Comment Letter of Kyle E. Carrick (Aug. 20, 1998) (``Carrick Comment
Letter'').
\78\ See BDO Seidman Comment Letter, at 9; Backus Comment
Letter.
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The Commission does not believe that the final rule amendment
imposes these costs. First, the Commission believes that the standard
it adopts today defines with precision when an accountant's conduct
will subject the accountant to Rule 102(e) proceedings. In fact, the
clarification of the Commission's standard for ``improper professional
conduct'' is one of the benefits of this final rule amendment. Second,
these commenters' concern that accountants will be held liable for a
single negligent mistake is addressed by the final rule amendment. As
described above, the Commission is not adopting a standard that reaches
single acts of simple negligence.
One commenter argued that the proposed rule's costs outweighed its
benefits because it applied to ``CPAs and CPA firms whose past errors
are not necessarily a precursor of future substandard practice.'' \79\
The Commission believes that the final rule amendment only reaches
accountants whose past violations demonstrate a lack of competence to
practice before the Commission.
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\79\ See ABA Comment Letter, at 7; see also BDO Seidman Comment
Letter, at 9 (stating that proposed amendment ``makes no distinction
between professionals who have erred and those who are likely to err
again'').
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According to this commenter, the ``elimination of individuals and
firms whose audit services are unreliable will undoubtedly have a
beneficial effect in preventing future investor losses.'' \80\ Weighed
against this benefit, this commenter identified the costs of bringing
Rule 102(e) proceedings and the costs ``associated with depriving the
public of the services of qualified auditors.'' \81\ This commenter
stated that the number of accounting firms providing auditing services
to public companies has declined sharply in the last 20 years and that
there is no assurance that a further decline might not lead to
increased audit fees.\82\
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\80\ Id.; see also BDO Seidman Comment Letter, at 9.
\81\ Id.
\82\ ABA Comment Letter, at 7.
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These comments seem directed at the costs and benefits of Rule
102(e) as a whole. The Commission only sought comment on the costs and
benefits of its proposal to clarify ``improper professional conduct,''
not the costs and benefits of Rule 102(e). Moreover, the Commission has
adopted a standard that is designed to reach only those accountants who
lack competence to practice before the Commission. The rule amendment
should not therefore ``deprive'' the public of the service of
``qualified auditors.'' The Commission therefore believes that the
costs and benefits described by the commenter will not be affected by
the particular standard adopted.
The Commission anticipates several benefits from the final rule
amendment. The amendment will provide clearer guidance to accountants.
Members of the accounting profession will better understand the
standard the Commission uses to determine ``improper professional
conduct.'' Also,
[[Page 57172]]
the clarified amendment will make it easier for the Commission, its
administrative law judges and the courts to administer the Rule, which
will further benefit the integrity of the Commission's processes. The
Commission notes that its standard requires in the first instance that
the accountant violate applicable professional standards. Therefore,
the rule imposes no obligation that accountants are not already subject
to. Rather, the amendment merely clarifies that when the Commission
finds that an accountant has violated the applicable professional
standards in circumstances meeting one of three standards of
culpability, that accountant has engaged in ``improper professional
conduct.'' The Commission also notes the existence of state accountancy
boards, which can discipline accountants for violations of professional
standards.
In addition, the federal securities laws and state law causes of
action may provide for sanctions against accountants for related
conduct. Therefore, accountants are already subject to liability and
disciplinary schemes that encourage accountants to comply with
applicable professional standards. After careful consideration of the
comments received, the Commission continues to believe that the
amendment will impose no costs.
VI. Efficiency, Competition and Capital Formation
Section 23(a)(2) of the Exchange Act requires the Commission to
consider the impact of its rules on competition. Moreover, Section 2(b)
of the Securities Act, Section 3(f) of the Exchange Act and Section
2(c) of the Investment Company Act of 1940 (``Investment Company Act'')
require the Commission, when engaged in rulemaking that requires a
public interest finding, to consider, in addition to the protection of
investors, whether the action will promote efficiency, competition and
capital formation.
The Commission requested data on what effect, if any, the proposed
amendment would have on efficiency, competition and capital formation.
No specific data was received in response to this request. One
commenter asserted that the rule as proposed would cause ``the steps
and costs to take a company public'' to escalate.\83\ This commenter
did not, however, provide any detail or explanation of why the proposed
rule would cause this effect.
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\83\ See Carrick Comment Letter.
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The Commission anticipates no effect on capital formation or
efficiency, as the rule amendment clarifies an existing standard.
Further, because the rule change applies equally to all accountants who
practice before the Commission, and because it clarifies an existing
standard, there should be no anti-competitive effect. In any event, the
Commission believes that any burden on competition imposed by this
amendment is necessary and appropriate in furtherance of the purpose of
the Exchange Act.
VII. Statutory Authority
The Commission is adopting the amendment to the rule pursuant to
its authority under Section 19(a) of the Securities Act, Section 23(a)
of the Exchange Act, Section 20(a) of the Public Utility Holding
Company Act of 1935, Section 319(a) of the Trust Indenture Act of 1939,
Section 211(a) of the Investment Advisers Act of 1940 and Section 38(a)
of the Investment Company Act.
Text of Amendment
List of Subjects in 17 CFR Part 201
Administrative practice and procedure, Investigations, Securities.
In accordance with the foregoing, Title 17, Chapter II of the Code
of Federal Regulations is amended as follows:
PART 201--RULES OF PRACTICE
1. The authority citation for Part 201, Subpart D continues to read
as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77h-1, 77j, 77s, 77u,
78c(b), 78d-1, 78d-2, 78l, 78m, 78n, 78o(d), 78o-3, 78s, 78u-2, 78u-
3, 78v, 78w, 79c, 79s, 79t, 79z-5a, 77sss, 77ttt, 80a-8, 80a-9, 80a-
37, 80a-38, 80a-39, 80a-40, 80a-41, 80a-44, 80b-3, 80b-9, 80b-11,
and 80b-12 unless otherwise noted.
2. Amend Sec. 201.102 by adding paragraphs (e)(1)(iv) to read as
follows:
Sec. 201.102 Appearance and practice before the Commission.
* * * * *
(e) Suspension and disbarment. (1) Generally.
(iv) With respect to persons licensed to practice as accountants,
``improper professional conduct'' under Sec. 201.102(e)(1)(ii) means:
(A) Intentional or knowing conduct, including reckless conduct,
that results in a violation of applicable professional standards; or
(B) Either of the following two types of negligent conduct:
(1) A single instance of highly unreasonable conduct that results
in a violation of applicable professional standards in circumstances in
which an accountant knows, or should know, that heightened scrutiny is
warranted.
(2) Repeated instances of unreasonable conduct, each resulting in a
violation of applicable professional standards, that indicate a lack of
competence to practice before the Commission.
* * * * *
By the Commission.
Dated: October 19, 1998.
Margaret H. McFarland,
Deputy Secretary.
Dissenting Statement of Commissioner Norman S. Johnson
Although I have the deepest respect for my esteemed colleagues, I
must dissent from the Commission's decision to issue today's
release.\1\ Despite the good faith demonstrated by my colleagues
throughout this difficult rulemaking process, I believe that the
Commission is repeating past mistakes by again attempting to ``push the
envelope'' of its permissible authority under Rule 102(e) of our Rules
of Practice, which governs the ability of professionals to practice
before the Commission. In my view, the Commission's release disregards
the plain import of the two Checkosky decisions of the United States
Court of Appeals for the District of Columbia Circuit.\2\ The release
amends our Rule of Practice 102(e) so that an accountant's single act
of negligence may amount, under some circumstances, to ``improper
professional conduct,'' with the likely result of depriving an
accountant of his or her livelihood.\3\
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\1\ The standard contained in today's release (the ``Standard'')
was adopted at an open meeting of the Commission on September 23,
1998. See SEC Defines ``Improper Professional Conduct'' by
Accountants, 1998 WL 649370 (S.E.C.) (News Release Sept. 23, 1998).
\2\ See Checkosky v. SEC, 23 F.3d 452 (D.C. Cir. 1994)
(``Checkosky I''); Checkosky v. SEC, 139 F.3d 221 (D.C. Cir. 1998)
(``Checkosky II''). The weight the Commission must attach to the
views of the D.C. Circuit cannot be overstated. Under the
jurisdictional provisions of the securities laws, every respondent
in a Commission administrative proceeding has the option of
appealing an adverse outcome to the D.C. Circuit. See, e.g., 15
U.S.C. 77i(a) & 78y(a)(1).
\3\ Amendment to Rule 102(e) of the Commission's Rules of
Practice, Securities Act Release No. 33-7593 (October 19, 1998) (the
``Release''). Before the recodification of the Commission's Rules of
Practice in 1995, Rule 102(e) was formerly designated Rule 2(e).
There are no substantive differences between the two rules. When
directly quoting pre-1995 materials, I have left references to
``Rule 2(e)'' intact; otherwise all references to the former Rule
2(e) appear as ``Rule 102(e).''
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The more than 150 comment letters we have received--the
overwhelming majority of them highly critical of the most important
part of the proposal--demonstrate that Rule 102(e) is a matter of
crucial importance to the accountants
[[Page 57173]]
who practice before the Commission.\4\ As Judge Randolph observed in
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Checkosky:
\4\ See, e.g., Richard I. Miller, General Counsel & Secretary,
American Institute of Certified Public Accountants (``AICPA''),
Comment Letter (``CL'') 84; Arthur Andersen LLP, CL 98; Ernst &
Young, LLP, CL 100; see also John M. Liftin, Chair, Committee on
Federal Regulation of Securities, and Richard H. Rowe, Chair,
Committee on Law and Accounting, American Bar Association, Section
of Business Law (``ABA''), CL 81.
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A proceeding under Rule 2(e) threatens ``to deprive a person of
a way of life to which he has devoted years of preparation and on
which he and his family have come to rely.'' * * * It is of little
comfort to an auditor defending against such charges that the
Commission's authority is limited to suspending him from agency
practice. For many public accountants such work represents their
entire livelihood. Moreover, when one jurisdiction suspends a
professional it can start a chain reaction.\5\
\5\ Checkosky I, 23 F.3d at 479 (Randolph, J.) (quoting Henry J.
Friendly, ``Some Kind of Hearing'', 123 U. Pa. L. Rev. 1267, 1297
(1975)). Almost without exception, the comment letters bear out
Judge Randolph's remarks, indicating that even if an accountant
receives ultimate vindication, the mere bringing of charges of
``improper professional conduct'' by the Commission may well have a
``career-crippling'' effect. See Arthur Andersen, CL 98 at 1 & 5-6;
see also, e.g., J.D. Fluno, Vice Chairman, W.W. Grainger, Inc., CL
75; ABA, CL 81 at 11.
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As nature abhors a vacuum, so does the Commission: its intentions
regarding the expansion of its Rule 102(e) authority have quickly
become apparent. Within days of the adoption of the new standard on
September 23, 1998, the Commission announced a major new initiative to
address improper accounting practices.\6\ It is clear to me that the
Commission intends for the expanded Rule 102(e) authority it has
arrogated to itself in today's release to be an important enforcement
weapon in this new initiative.
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\6\ Remarks by SEC Chairman Arthur Levitt, The ``Numbers Game'',
New York University Center for Law and Business (Sept. 28, 1998)
<http://www.sec.gov/news/speeches/spch220.txt>; SEC Press Release
98-95 (Sept. 28, 1998) <http:// www.sec.gov/news/press/98-95.txt>
(announcing ``a major address on the state of accounting'' that will
express Commission ``concern that the quality of financial reporting
in corporate America is eroding and * * * [will] present an action
plan that calls on the entire financial community to remedy the
problem''); see Jube Shiver Jr., SEC to Crack Down on Inflated
Earnings, L.A. Times, Sept. 29, 1998, at B1; see also Saul Hansell,
S.E.C. Crackdown on Technology Write-Offs, N.Y. Times, Sept. 29,
1998, at C1.
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The proponents of the amendment claim that it is significantly more
protective of accountants than the standard set forth in the
Commission's June 1998 proposing release.\7\ I disagree. I think that
the proposed standard will not preclude the Commission from instituting
Rule 102(e) proceedings for simple negligence.
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\7\ Proposed Amendment to Rule 102(e) of the Commission's Rules
of Practice, Securities Act Release No. 7546, 1998 WL 311988
(S.E.C.) (June 12, 1988), 63 Fed. Reg. 33305 (June 18, 1998) (the
``Proposing Release'').
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For close to thirty years, I have followed the Commission's Rule
102(e) proceedings indeed, long ago I wrote two articles on the
subject.\8\ In my view, today's release represents another wrong turn
in the Commission's Rule 102(e) jurisprudence. Previous wrong turns
resulted in the two Checkosky opinions by the D.C. Circuit. Rule 102(e)
differs fundamentally from the securities laws enforced by the
Commission. The purpose of the securities laws is to protect investors,
while the professed purpose of Rule 102(e) is to protect the integrity
of the Commission's administrative processes. Under today's proposal,
Rule 102(e) will be just another weapon in the Commission's enforcement
arsenal. The use of Rule 102(e) as just another enforcement tool
eliminates the underpinning of those few Court decisions that have
upheld, in the most general terms possible, the Commission's ability
even to promulgate Rule 102(e). Thus, the Commission's ability to bring
any Rule 102(e) proceeding--under any standard, against even the most
egregious violators--may now be in jeopardy. Even assuming the
Commission has adequate authority to promulgate Rule 102(e), both
Checkosky opinions indicate that the Commission lacks authority to
adopt the sort of negligence standard contained in the Release. Under
Checkosky, the Commission may only discipline professionals under Rule
102(e) when scienter, including recklessness, is shown.\9\
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\8\ See Norman S. Johnson, The Dynamics of SEC Rule 2(e): A
Crisis for the Bar, 1975 Utah L. Rev. 629; Norman S. Johnson, The
Expanding Responsibilities of Attorneys in Practice Before the SEC:
Disciplinary Proceedings Under Rule 2(e) of the Commission's Rules
of Practice, 25 Mercer L. Rev. 637 (1974).
\9\ See Robert D. Potts, Exchange Act Release No. 39126, 1997 WL
690519 (S.E.C.), at *12 (Sept. 29, 1997) (Commissioner Johnson,
concurring), aff'd on other grounds, 151 F.3d 810 (8th Cir. 1998);
David J. Checkosky, Exchange Act Release No. 38183, 1997 WL 18303
(S.E.C.), at *14 (Jan. 21, 1997) (Commissioner Johnson, dissenting),
rev'd, Checkosky II, 139 F.3d 221.
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My long-standing interest in the Commission's Rule 102(e)
jurisprudence, as well as my deep-rooted objections to the rule's
expansive and improper uses, leads me to set forth my dissenting views
at some length and in the following order:
<bullet> Because it is impossible to evaluate fairly today's
release without consideration of the Commission's past missteps, I
outline the history of Rule 102(e) in the first section.
<bullet> Next, in the second section, I discuss the Checkosky case,
including the D.C. Circuit's two reversals of Commission opinions.
<bullet> In the third section, I explain the basis for my view that
the Commission lacks legal authority even to promulgate Rule 102(e),
and that, in any event, the Commission lacks the legal authority to
adopt a negligence standard under Rule 102(e).
<bullet> In the fourth section, I demonstrate that the Standard is
vague, and that it does not comply with the mandate of both Checkosky I
and Checkosky II that we adopt a clear standard.
<bullet> In the fifth section, I set forth the various reasons
why--even assuming adequate legal authority and clarity--it is not in
the public interest for the Commission to adopt the Standard.
<bullet> Next, in the sixth section, I question whether the
Commission gave adequate notice in its Proposing Release that it might
adopt certain aspects of today's release.
<bullet> Finally, in the seventh section, I set forth the likely
ways in which the Commission will seek to expand its Rule 102(e)
authority in the future.
I. ``Administrative Oaks'' and ``Legislative Acorns'': A Brief
History of Rule 102(E)
In one of its landmark securities decisions restricting the growth
of implied private actions under the federal securities laws, the
Supreme Court remarked that Rule 10b-5 was ``a judicial oak which has
grown from little more than a legislative acorn.'' \10\ The
Commission's use of Rule 102(e) to regulate professional conduct might
similarly be described as an ``administrative oak'' growing out of a
``legislative acorn.'' There is no express statutory provision
authorizing the Commission to discipline professionals; instead, a
handful of courts have upheld the Commission's promulgation of Rule
102(e) as impliedly proper because the rule is `` `reasonably related'
to the purposes of the securities laws.'' \11\ I fully subscribe to the
views of a distinguished predecessor, Commissioner Roberta Karmel, who
observed in a Rule 102(e) case almost twenty years ago that ``[t]he
administrative implication of
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prosecutorial remedies under federal legislation is rife with the same
evil'' possessed by ``judicial implication of private rights of
action.'' \12\ In my view, the same disfavor the Supreme Court has
enunciated towards implied private rights of action is equally
applicable--and probably more so--to implied prosecutorial remedies
such as those the Commission utilizes under Rule 102(e).\13\
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\10\ Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 732, 737
(1975).
\11\ Checkosky I, 23 F.3d at 455 (Silberman, J.) (quoting Touche
Ross & Co. v. SEC, 609 F.2d 570, 582 (2d Cir. 1979)); see also,
e.g., Daniel L. Goelzer & Susan Ferris Wyderko, Rule 2(e):
Securities and Exchange Commission Discipline of Professionals, 85
Nw. U. L. Rev. 652, 652 (1991) (lawyers and accountants ``are not
subject to direct regulation under the federal securities laws,''
and their licensing and discipline is ``largely a matter committed
to state licensing bodies and professional associations'').
\12\ Keating, Muething & Klekamp, 47 S.E.C. 95, 111 (1979)
(Commissioner Karmel, dissenting). Unfortunately, Commissioner
Karmel dissented in the context of a settled enforcement action, so
there was no opportunity for judicial review of the issues she
raised. Several commentators have suggested that attempts to evade
appellate review are a hallmark of the Commission's Rule 102(e)
jurisprudence. See, e.g., Ann Maxey, SEC Enforcement Actions Against
Securities Lawyers: New Remedies v. Old Policies, 22 Del. J. Corp.
L. 537, 552-53 (1997); Richard W. Painter & Jennifer E. Duggan,
Lawyer Disclosure of Corporate Fraud: Establishing a Firm
Foundation, 50 S.M.U. L. Rev. 225, 271 (1996).
\13\ See Touche Ross & Co. v. Redington, 442 U.S. 560 (1979);
see also, e.g., Central Bank v. First Interstate Bank, 511 U.S. 164
(1994); Keating, 47 S.E.C. at 111 & 116 n.35 (Commissioner Karmel,
dissenting). The Supreme Court has approved the use of implied
ancillary remedies, such as when the Commission seeks, e.g.,
disgorgement as a remedy in a typical enforcement action, but that
situation seems readily distinguishable from Rule 102(e), in which
both the cause of action and its remedy are implied. Cf. Franklin v.
Gwinnett County Public Schools, 503 U.S. 50 (1992) (approving
implied remedy to express cause of action).
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The Commission first promulgated Rule 102(e) in 1935.\14\ In its
initial form, the rule contained a requirement that attorneys be
admitted to practice before the Commission (as was then required of
attorneys and accountants who sought to represent persons before the
Internal Revenue Service).\15\ In 1938, however, the Commission struck
the admission requirement, and since then the rule's only use has been
to permit the Commission to censure, suspend or disbar
professionals.\16\
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\14\ See Touche Ross & Co. v. SEC, 609 F.2d 570, 578 n.13 (2d
Cir. 1979) (``Touche Ross''); Harold Marsh, Jr., Rule 2(e)
Proceedings, 35 Bus. Law. 987, 987 (1980).
\15\ Marsh, supra note 14, 35 Bus. Law. at 987.
\16\ Id. Although Rule 102(e) reaches all types of professionals
who might practice before the Commission, including engineers or
expert witnesses, there have been only a few cases in the rule's 63-
year history that did not involve either a lawyer or an accountant.
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Although Rule 102(e) has caused a great deal of controversy since
its inception,\17\ it was only used sparingly
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during the first 35 years or so of its existence.\18\ Things changed in
the early 1970's when the Commission embarked on its so-called
``access'' theory of securities law enforcement.\19\ As a consequence
of its belief that access to capital markets is controlled by a limited
number of professionals, the Commission sought to achieve maximum
deterrent value from its limited enforcement resources by suing the
gatekeepers, rather than simply proceeding against the principal
wrongdoers.\20\ Accordingly, the Commission brought wave-upon-wave of
actions--including many Rule 102(e) administrative proceedings--against
securities professionals, accountants and lawyers.\21\
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\17\ The following is a sampling of the literature discussing
the Commission's use of Rule 102(e), the vast bulk of it
extraordinarily critical--particularly when one discounts articles
by Commission officials defending policies they themselves have
helped formulate and administer. (I find it ironic that the number
of law review articles discussing Rule 102(e) dwarfs the number of
actual federal court decisions construing it by a factor of
approximately 10 to 1). See, e.g., Roberta S. Karmel, Regulation by
Prosecution: The Securities and Exchange Commission vs. Corporate
America 173-83 (1982); ABA, Statement of Policy Adopted by ABA
Regarding Responsibilities and Liabilities of Lawyers in Advising
with Respect to the Compliance of Clients with Laws Administered by
the Securities and Exchange Commission, 31 Bus. Law. 543, 545
(1975); ABA Task Force on Rule 102(e) Proceedings, Report of the
Task Force on Rule 102(e) Proceedings: Rule 102(e) Sanctions Against
Accountants, 52 Bus. Law. 965 (1997); David H. Barber, Lawyer Duties
in Securities Transactions Under Rule 2(e): The Carter Opinions,
1982 B.Y.U. L. Rev. 513; Arthur Best, Shortcomings of Administrative
Agency Lawyer Discipline, 31 Emory L.J. 535 (1982); Judah Best, In
Opposition to Rule 2(e) Proceedings, 36 Bus. Law. 1815 (1981);
Dennis J. Block & Charles J. Ferris, SEC Rule 2(e)--A New Standard
for Ethical Conduct or an Unauthorized Web of Ambiguity, 81 Cap. U.
L. Rev. 501 (1982); John C. Burton, SEC Enforcement and Professional
Accountants: Philosophy, Objectives and Approach, 28 Vand. L. Rev.
19 (1975); Michael P. Cox, Regulation of Attorneys Practicing Before
Federal Agencies, 34 Case W. Res. L. Rev. 173 (1984); Joseph C.
Daley & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries
at the Bar of the SEC, 24 Emory L.J. 747 (1975); Mitchell F. Dolin,
SEC Rule 2(e): After Carter-Johnson: Toward a Reconciliation of
Purpose and Scope, 9 Sec. Reg. L.J. 331 (1982); James R. Doty et
al., The Professional as Defendant, in 23rd Annual Institute on
Securities Regulation 681 (PLI Corp. Law & Practice Course Handbook
Series No. B4-6978, 1991); Robert A. Downing & Richard L. Miller,
Jr., The Distortion and Misuse of Rule 2(e), 54 Notre Dame Law. 774
(1979); Robert W. Emerson, Rule 2(e) Revisited: SEC Disciplining of
Attorneys since In re Carter, 29 Am. Bus. L.J. 155 (1991); Ralph C.
Ferrara, Administrative Disciplinary Proceedings Under Rule 2(e), 36
Bus. Law. 1807 (1981); Ted J. Fiflis, Choice of Federal or State Law
for Attorneys' Professional Responsibility in Securities Matters, 56
N.Y.U. L. Rev. 1236 (1981); Monroe H. Freedman, A Civil Libertarian
Looks at Securities Regulation, 35 Ohio St. L.J. 280 (1974); Ray
Garrett, Jr., Social Responsibility of Lawyers in Their Professional
Capacity, 30 U. Miami L. Rev. (1976); Daniel L. Goelzer, The SEC and
Opinion Shopping: A Case Study in the Changing Regulation of the
Accounting Profession, 52 Brook. L. Rev. 1057 (1987); Stuart C.
Goldberg, Policing Responsibilities of the Securities Bar: The
Attorney-Client Relationship and the Code of Professional
Responsibility--Considerations for Expertizing Securities Attorneys,
19 N.Y.L.F. 221 (1973); Paul Gonson, Disciplinary Proceedings and
Other Remedies Available to the SEC, 30 Bus. Law. 191 (1975); Kent
Gross, Attorneys and Their Corporate Clients: SEC Rule 2(e) and the
Georgetown ``Whistle Blowing'' Proposal, 3 Corp. L. Rev. 197 (1980);
Samuel H. Gruenbaum, The SEC's Use of Rule 2(e) to Discipline
Accountants and Other Professionals, 56 Notre Dame Law. 820 (1981);
Samuel H. Gruenbaum & Marc I. Steinberg, Accountants' Liability and
Responsibility: Securities, Criminal and Common Law, 13 Loy. L.A. L.
Rev. 247 (1980); Stanley A. Kaplan, Some Ruminations on the Role of
Counsel for a Corporation, 56 Notre Dame L. Rev. 873 (1981); Roberta
S. Karmel, A Delicate Assignment: The Regulation of Accountants by
the SEC, 56 N.Y.U. L. Rev. 959 (1981); Roberta S. Karmel, Attorneys'
Securities Law Liabilities, 27 Bus. Law. 1153 (1972); John J.
Kelleher, Scourging the Moneylenders from the Temple: The SEC, Rule
2(e) and the Lawyers, 17 San Diego L. Rev. 501 (1980); Michael R.
Klein, The SEC and the Legal Profession: Material Adverse
Developments, 11 Inst. on Sec. Reg. (PLI) 604 (1979); Reynold Kosek,
Professional Responsibility of Accountants and Lawyers Before the
Securities and Exchange Commission, 72 L. Libr. J. 453 (1979);
Steven C. Krane, The Attorney Unshackled: SEC Rule 2(e) Violates
Clients' Sixth Amendment Right to Counsel, 57 Notre Dame L. Rev. 50
(1981); Werner Kronstein, The Carter-Johnson Case: A Higher
Threshold for SEC Actions Against Attorneys, 9 Sec. Reg. L.J. 293
(1981); Michael R. Lanzarone, Professional Discipline: Unfairness
and Inefficiency in the Administrative Process, 51 Fordham L. Rev.
818 (1983); Philip H. Levy, Regulation of the Accounting Profession
Through Rule 2(e) of the SEC's Rules of Practice: Valid or Invalid
Exercise of Power?, 46 Brook. L. Rev. 1159 (1980); Frederick D.
Lipman, The SEC's Reluctant Police Force: A New Role for Lawyers, 49
N.Y.U. L. Rev. 437 (1974); Simon M. Lorne, The Corporate and
Securities Adviser, the Public Interest, and Professional Ethics, 76
Mich. L. Rev. 423 (1978); Lewis D. Lowenfels, Expanding Public
Responsibilities of Securities Lawyers: An Analysis of the New Trend
in Standard of Care and Priorities of Duties, 74 Colum. L. Rev. 412
(1974); Harold L. Marquis, An Appraisal of Attorneys'
Responsibilities Before Administrative Agencies, 26 Case W. Res. L.
Rev. 285 (1976); Arthur F. Mathews, SEC Injunctive Proceedings
Against Attorneys, 36 Bus. Law. 1819 (1981); Christine Neylon
O'Brien, SEC Regulation of the Accounting Profession: Rule 2(e), 21
Gonz. L. Rev. 675 (1985); L. Ray Patterson, The Limits of the
Lawyer's Discretion and the Law of Legal Ethics: National Student
Marketing Revisited, 1979 Duke L.J. 1251; Marvin G. Pickholtz, SEC
Regulation of Professionals, 4 Rev. Fin. Serv. Reg. 165 (1988);
Irving M. Pollack, The SEC Lawyer: Who is His Client and What are
His Responsibilities?, 49 Geo. Wash. L. Rev. 453 (1981); Martin B.
Robins, Policeman, Conscience or Confidant: Thoughts on the
Appropriate Response of a Securities Attorney Who Suspects Client
Violations of the Federal Securities Laws, 15 J. Marshall L. Rev.
373 (1982); Michel Rosenfeld, The Transformation of the Attorney-
Client Privilege: In Search of an Ideological Reconciliation of
Individualism, the Adversary System, and the Corporate Client's SEC
Disclosure Obligations, 33 Hastings L.J. 495 (1982); Quinton F.
Seamons, Inside the Labyrinth of the Elusive Standard Under the
SEC's Rule 2(e), 23 Sec. Reg. L.J. 57 (1995); Morgan Shipman, The
Need for SEC Rules to Govern the Duties and Civil Liabilities of
Attorneys Under the Federal Securities Statutes, 34 Ohio St. L.J.
231 (1973); George J. Siedel, Rule 2(e) and Corporate Officers, 39
Bus. Law. 455 (1984); Marshall L. Small, An Attorney's
Responsibilities Under Federal and State Securities Laws: Private
Counselor or Public Servant?, 61 Cal. L. Rev. 1189 (1973); Mindy
Jaffe Smolevitz, The Opinion Shopping Phenomenon: Corporate
America's Search for the Perfect Auditor, 52 Brook. L. Rev. 1077
(1987); Theodore Sonde, Professional Disciplinary Proceedings, 30
Bus. Law. 157 (1975); Marc I. Steinberg, Attorney Liability Under
the Securities Laws, 45 Sw. L.J. 711 (1991); Wallace L. Timmeny,
Responsibilities of Lawyers in Connection with the Sale of Municipal
Securities, 36 Bus. Law. 1799 (1981); Francis M. Wheat, The Impact
of SEC Professional Responsibility Standards, 34 Bus. Law. 969
(1979); David B. Wilkins, Who Should Regulate Lawyers?, 105 Harv. L.
Rev. 799 (1992); Harold M. Williams, Corporate Accountability and
the Lawyer's Role, 34 Bus. Law. 7 (1978); Marie L. Coppolino, Note,
Rule 2(e) and the Auditor: How Should the Securities and Exchange
Commission Define its Standard of Professional Conduct?, 63 Fordham
L. Rev. 2227 (1995); Michael J. Crane, Note, Disciplinary
Proceedings Against Accountants: The Need for a More Ascertainable
Improper Professional Conduct Standard in the SEC's Rule 2(e), 53
Fordham L. Rev. 351 (1984); Robert G. Day, Note, Administrative
Watchdogs or Zealous Advocates? Implications for Legal Ethics in the
Face of Expanded Attorney Liability, 45 Stan. L. Rev. 645, 673
(1993); William Kenneth C. Dippel, Comment, Attorney Responsibility
and Carter Under SEC Rule 2(e): The Powers That Be and the Fear of
the Flock, 36 Sw. L.J. 897 (1982); Todd J. Flagel, Note, Securities
Law: SEC Must Clarify Its Position as to the Level of Culpability
that Must Be Shown to Constitute a Rule 2(e)(1)(ii) Violation By
Accountants, 20 Dayton L. Rev. 1083 (1995); Note, Attorney
Discipline by the SEC: 2(e) or not 2(e)?, 17 New Eng. L. Rev. 1267
(1982); Note, The Duties and Obligations of the Securities Lawyer:
The Beginning of a New Standard for the Legal Profession?, 1975 Duke
L.J. 121; Note, SEC Disciplinary Proceedings Against Attorneys Under
Rule 2(e), 79 Mich. L. Rev. 1270 (1981); Comment, SEC Disciplinary
Rules and the Federal Securities Laws: The Regulation, Role and
Responsibilities of the Attorney, 1972 Duke L.J. 969.
\18\ As to the lawyers, the first Rule 102(e) proceeding was not
brought until 1950, and only five cases were brought before 1960.
See Keating, 47 S.E.C. at 112 (Commissioner Karmel, dissenting). The
number of Rule 102(e) cases against accountants during from 1935 to
1970 was also de minimis by comparison to recent years when the
Commission has brought (according to statistics supplied by our
Office of the Chief Accountant) an average of over 25 cases
annually. See Marsh, supra note 14, 35 Bus. Law. at 987-89.
Commentators seem to agree that, for various reasons, it is
impossible to obtain accurate historical statistics regarding Rule
102(e) proceedings, particularly for the period before 1975. See
Emerson, supra note 17, 29 Am. Bus. L.J. at 173-83 (comprehensive
effort to tabulate number and type of Rule 102(e) proceedings
against lawyers through 1989); Marsh, supra note 14, 35 Bus. Law. at
988.
\19\ See, e.g., Burton, supra note 17, 28 Vand. L. Rev. at 19-
20; Simon M. Lorne & W. Hardy Callcott, Administrative Actions
Against Lawyers Before the SEC, 50 Bus. Law. 1293, 1297 (1995);
Maxey, supra note 12, 22 Del. J. Corp. L. at 549.
\20\ Harvey L. Pitt & Karen L. Shapiro, Securities Regulation by
Enforcement: A Look Ahead at the Next Decade, 7 Yale J. on Reg. 149,
171-74 (1990).
\21\ Id.; see also Emerson, supra note 17, 29 Am. Bus. L.J. at
176 (for attorneys, peak years of Rule 102(e) enforcement activity
were 1975 through 1977, when the Commission brought actions against
53 attorneys and three law firms).
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The high water mark of the Commission's ``access'' theory was
probably the National Student Marketing case.\22\ In National Student
Marketing, the Commission brought an injunctive action that charged two
nationally prominent law firms and several of their respective partners
with aiding and abetting a securities fraud based on their alleged
failure to take proper action when they ``permitted'' their clients to
complete a merger that had received shareholder approval based on a
proxy statement containing materially misleading financial
information.\23\ The Commission's complaint alleged that the lawyers
had a duty to insist that their clients resolicit proxies based on
corrected information, and that, if the clients refused to follow this
advice, the lawyers were required to resign and to report the alleged
securities violations to the Commission.\24\ In practical terms, the
Commission sought to make involuntary ``whistle-blowers'' or government
agents out of private counsel by ``plac[ing] upon the lawyer a
responsibility to investigate his clients'' activities in search for
possible violations of law.'' \25\
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\22\ SEC v. National Student Marketing Corp., [1971-1972
Transfer Binder] Fed. Sec. L. Rep. (CCH) para. 93,360, at 91,913
(D.D.C. 1972) (complaint). Less than two weeks after the filing of
the National Student Marketing complaint, the Wall Street Journal
reported that it had become the ``best-read document since Gone With
the Wind.'' Green, Irate Attorneys--A Bid to Hold Lawyers
Accountable to Public Stuns, Angers Firms, Wall St. J., Feb. 15,
1972, at 1, col. 1; see also Samuel H. Gruenbaum, Corporate/
Securities Lawyers: Disclosure, Responsibility, Liability to
Investors, and National Student Marketing Corp., 54 Notre Dame Law.
795 (1979).
\23\ National Student Marketing, [1971-1972 Transfer Binder]
Fed. Sec. L. Rep. (CCH) para. 93,360, at 91,913; see also Lorne,
supra note 17, 76 Mich. L. Rev. at 455.
\24\ SEC v. National Student Marketing Corp., [1971-1972
Transfer Binder] Fed. Sec. L. Rep. (CCH) para. 93,360 at para.
48(i).
\25\ Milton V. Freeman, Recent Governmental Attacks on the
Private Lawyer as an Infringement of the Constitutional Right to
Counsel, 36 Bus. Law. 1791, 1792 (1981); see Cox, supra note 17, 34
Case W. Res. L. at 204 (referring to attempts by Commission towards
the ``enlistment of attorneys as agents of the government'');
Wilkins, supra note 17, 105 Harv. L. Rev. at 836 (Commission has
appeared to engage in ``overzealous enforcement'' actions against
lawyers in order to encourage them to serve as watchdogs over their
clients). Accord Mathews, supra note 17, 36 Bus. Law. at 1829; Marc
I. Steinberg, Attorney Liability for Client Fraud, 1991 Colum. Bus.
L. Rev. 1, 9.
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In discussing National Student Marketing, one Commissioner went so
far as to state that, at least in the context of a securities
transaction, a lawyer's role was ``more akin to that of an auditor,''
i.e., the lawyer would ``have to exercise a measure of independence''
from his client and would have to be ``acutely cognizant of his
responsibility to the public who engage in securities transactions that
would never have come about if not for his professional presence.''
\26\ Although the Commission brought National Student Marketing as an
injunctive action in federal court, it soon changed its emphasis in
professional discipline cases and increasingly brought them as
administrative proceedings under Rule 102(e).\27\
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\26\ A.A. Sommer, The Emerging Responsibilities of the
Securities Lawyer, [1973-1974 Transfer Binder] Fed. Sec. L. Rep.
(CCH) para. 79,631, 83,686, at 83,689 to 83,690 (Jan. 24, 1974). I
have the highest regard for former Commissioner Sommer, but I have
long believed that this notion of lawyer as auditor is contrary to
traditional canons of professional responsibility. See Johnson,
supra note 8, 1975 Utah L. Rev. at 645-50.
\27\ During the 1970's, federal courts increasingly placed
limitations on the Commission's ability to bring suit and obtain
injunctive relief. See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S.
185, 197-198 (1976) (proof of scienter required in a Rule 10b-5
action); SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90,
98 (2d Cir. 1978) (``current judicial attitude toward the issuance
of injunctions on the basis of past violations at the SEC's request
has become more circumspect than in earlier days''). Convincing
evidence exists demonstrating that the Commission increased its use
of Rule 102(e) administrative proceedings after National Student
Marketing as a means to circumvent these judicially-imposed
limitations. See Downing & Miller, supra note 17, 54 Notre Dame Law.
at 783-85 (quoting June 1976 memorandum from Commission's General
Counsel to Commission's Chairman suggesting that the Commission
might appropriately bring Rule 102(e) actions in situations in which
a professional's conduct would not satisfy the Hochfelder
requirement of scienter for Rule 10b-5 actions); see also, e.g.,
Arthur Best, supra note 17, 31 Emory L.J. at 550 (lesser negligence
standard ``may explain why SEC chose'' to bring Rule 102(e) action,
rather than injunctive action against major accounting firm, and
this option ``can be viewed either as an advantage of the
administrative process or as a dangerous discretionary weapon that
ought not to be available to the agency''); James P. Hemmer,
Resignation of Corporate Counsel: Fulfillment or Abdication of Duty,
39 Hastings L.J. 641, 650 (1988) (``The unwillingness of the courts
to issue injunctions when there is no likelihood of recurring
violation * * * is at least one of the principal factors in the
SEC's increasing use of rule 2(e) proceedings to govern the
discipline of professionals.'').
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Although National Student Marketing involved charges against law
firms and individual lawyers, the Commission did not limit its
overreaching to the legal profession--indeed, one contemporaneous
commentary referred to accountants as the ``most actively besieged
profession'' under Rule 102(e).\28\ In SEC v. Arthur Young & Co., a
case arising from the activities of an oil and gas venture promoter
over a seven-year period in the 1960's, the Commission charged a
nationally prominent accounting firm and the responsible auditors with
committing or aiding and abetting securities fraud.\29\ Because the
case predated the Supreme Court's decision requiring the Commission to
prove scienter in its Rule 10b-5 enforcement cases,\30\ the Ninth
Circuit assumed that ``negligence, rather than scienter, constitutes
the standard by which an accountant's or auditor's
[[Page 57176]]
performance must be measured.''\31\ Before the district court, the
Commission argued that the firm and its auditors performed their work
``with blinders on'' and that they should have done ``more'' to reveal
the risks to those who invested in the ventures.\32\ On appeal, the
Commission apparently argued that the accountants had failed to perform
their audit in a manner that would have revealed to ``an ordinary
prudent investor, who examined the * * * audits or financial
statements, a reasonably accurate reflection of the financial risks * *
*.'' \33\ The Ninth Circuit rejected both formulations of the
Commission's argument, noting:
\28\ See Downing & Miller, supra note 17, 54 Notre Dame Law. at
775 n.6; see also id. at 774 (``Recent 2(e) proceedings against
accountants demonstrate that the SEC has converted the rule from one
designed to serve the limited salutary purpose of exercising
disciplinary authority over the incompetent, unethical or dishonest
accounting practitioner to a rule which has effectively been
utilized to pervasively regulate accounting firms and the profession
as a whole.'').
\29\ 590 F.2d 785, 786 (9th Cir. 1979).
\30\ Aaron v. SEC, 446 U.S. 680 (1980).
\31\ 590 F.2d at 787.
\32\ 590 F.2d at 787.
\33\ 590 F.2d at 787-88.
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To accept the SEC's position would go far toward making the
accountant both an insurer of his client's honesty and an
enforcement arm of the SEC. We can understand why the SEC wishes to
so conscript accountants. Its frequently late arrival on the scene
of fraud and violations of the securities laws almost always suggest
that had it been there earlier with the accountant it would have
caught the scent of wrong-doing and, after an unrelenting hunt,
bagged the game. What it cannot do, the thought goes, the accountant
can and should. The difficulty with this is that Congress has not
enacted the conscription bill that the SEC seeks to have us fashion
and fix as an interpretive gloss on existing securities laws.\34\
\34\ 590 F.2d at 788.
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To be sure, the Commission's attitude towards the conscription of
accountants--and their purported wearing of ``blinders,'' or failures
to observe and respond to ``red flags''--persists to this day.\35\
---------------------------------------------------------------------------
\35\ In a later case upholding disciplinary sanctions imposed by
the Commission on an accountant under Rule 102(e), the Ninth Circuit
purported to distinguish Arthur Young. See Davy v. SEC, 792 F.2d
1418, 1422 (9th Cir. 1986). I confess to being confused by Davy--one
would think that if the Commission were barred from directly
``conscript[ing] accountants'' under the substantive securities
laws, it would also be barred from indirectly ``conscript[ing]
accountants'' under Rule 102(e). The real distinction seems to be
that Davy, unlike Arthur Young, involved truly egregious scienter-
based misconduct by an accountant. See 792 F.2d at 1422 (referring
to Commission finding, supported by ``substantial evidence,'' that
the accountant ``knowingly participated in the fraud practice by
[the issuer] on the investing public''). In any event, Davy does not
support the Commission's adoption of the Standard, because the Court
went to great lengths to limit its holding:
We do not consider whether cases can arise in which the SEC in
Rule 2(e) matters exceeds its proper jurisdictional boundaries. The
precise reach of the SEC in these situations has not been defined
and we leave that task for a future case which implicates that
question directly.
Id.; see also id. (``there may be cases where the SEC should not
be empowered to determine the standards by which accountants, or
attorneys for that matter, are to be judged''; ``[w]e pretermit any
discussion of the SEC's power to determine standards for discipline
under Rule 2(e) until we have the issue squarely before us'').
---------------------------------------------------------------------------
Many legal scholars and members of the securities bar and industry,
myself among them, decried the Commission's overreaching in National
Student Marketing, Arthur Young and similar cases.\36\ One commentary
described the Commission's efforts, colorfully but accurately, as a ``
`reign of terror' on broker-dealers, accountants and attorneys.'' \37\
Indeed, for more than twenty-five years, the Commission's attempts to
set standards for professional conduct, under Rule 102(e) and
otherwise, have caused much dissension on the Commission itself.\38\
The roster of distinguished former Commissioners who have expressed
serious doubts about the Commission's expansive uses of Rule 102(e) and
other attempts to set professional standards includes: Edward H.
Fleischman, Roberta S. Karmel, Philip Lochner, Jr., Richard Y. Roberts,
and Steven M.H. Wallman.\39\
---------------------------------------------------------------------------
\36\ See, e.g., Daley & Karmel, supra note 17, 24 Emory L.J.
747; Downing & Miller, supra note 17, 54 Notre Dame Law. 774;
Freeman, supra note 25, 36 Bus. Law. 1791; Johnson, supra note 8,
1975 Utah L. Rev. 629; Johnson, supra note 8, 25 Mercer L. Rev. 637.
\37\ Dennis J. Block & Jonathan M. Hoff, SEC Moves Against
Attorneys Under the Remedies Act, N.Y.L.J., Sept. 23, 1993, at 5
(quoting Harvey L. Pitt & Dixie L. Johnson, Justice Delayed, Justice
Denied: Observations on the SEC's `Kern' Decision, N.Y.L.J., July
11, 1991, at 5).
\38\ See, e.g., Keating, 47 S.E.C. at 109 (Commissioner Karmel,
dissenting); Richard E. Brodsky, P.A., CL 54.
\39\ Keating, 47 S.E.C. at 112 (1979) (Commissioner Karmel,
dissenting); see also Potts, 1997 WL 690519 (S.E.C.), at *17
(Commissioner Wallman, dissenting); David J. Checkosky, 50 S.E.C.
1180, 1198 (1992) (Commissioner Roberts, concurring in part and
dissenting in pertinent part); Allied Stores Corp., 1987 SEC LEXIS
4306, at *19 (June 29, 1987) (Commissioner Fleischman, dissenting);
Richard Y. Roberts, CL 18.
It appears that the Rule 102(e) skeptics on the Commission have
not always been in the minority. See Potts, 1997 WL 690519 (S.E.C.),
at *12 (Commissioner Johnson, concurring) (noting that the
Commission was ``evenly split two-two'' on the issue of whether a
single act of mere negligence was sufficient for liability under
Rule 102(e)); see also Checkosky I, 23 F.3d at 487 (discussing media
reports that, at a preliminary stage, three Commissioners had voted
to overturn the `` `harsh sanction' '' imposed by the Administrative
Law Judge); David J. Checkosky, 50 S.E.C. at 1182 (denying
respondents' ``factual assertion that * * * the Commission had
[earlier] rendered a final opinion in this case and improperly
refused to publish it'').
---------------------------------------------------------------------------
Much of the criticism of the Commission's efforts in this area has
focussed on two factors. First, neither the Commission nor its
administrative law judges (``ALJ's'') have a statutory mandate to
establish ethical standards nor any special expertise in the area of
professional responsibility; second, the threat of disciplinary action
might well intimidate and interfere with the exercise of independent
professional judgment and, as to lawyers, might deprive clients of
their constitutional right to counsel.\40\ These fears were far from
academic: the National Student Marketing case clearly affected the
ability and willingness of the securities bar to take zealous positions
before the Commission.\41\ According to an article co-written by the
then-General Counsel of the Commission, the controversy caused by
National Student Marketing and similar cases became so heated that it
affected ``the Commission's ability to carry out its statutory
mandates,'' because it lessened the necessary cooperation and trust
between the Commission, its staff and the securities bar and
industry.\42\
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\40\ See Keating, 47 S.E.C. at 112-17 & n.31 (1979)
(Commissioner Karmel, dissenting); see also, e.g., Kivitz v. SEC,
475 F.2d 956, 962 (D.C. Cir. 1973) (reversing Commission finding of
liability in Rule 102(e) disbarment case; declining to give
Commission any deference in matters of alleged professional
misconduct); Judah Best, supra note 17, 36 Bus. Law. at 1817;
Freeman, supra note 25, 36 Bus. Law. at 1792-94; Lorne & Callcott,
supra note 19, 50 Bus. Law. at 1301-03.
\41\ Cf. Lorne, supra note 17, 76 Mich. L. Rev. at 455-56
(recounting post-National Student Marketing incident in which a
lawyer, unable to compel disclosure, resigned from his law firm and
reported the matter to the SEC; after the disclosure was made, a
class action lawsuit followed that was settled upon payment of
$785,000, $625,000 of which came from the lawyer's former firm, and
only $160,000 from the client).
\42\ Lorne & Callcott, supra note 19, at 1300-01 (referring to
actions against lawyers).
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In response to the well-deserved firestorm of criticism caused by
National Student Marketing and similar cases, the Commission
retreated.\43\ As to lawyers, the Commission announced that it would
commence Rule 102(e) actions only where it could demonstrate scienter
and that it would cease bringing ``original'' Rule 102(e) actions
(i.e., the Commission would only bring an administrative proceeding
against a lawyer if a federal court first determined that the lawyer
had violated the federal securities laws).\44\ As to accountants, the
[[Page 57177]]
situation was less clear, but, at least for a time, the Commission
seemed less aggressive in bringing Rule 102(e) actions against them as
well.\45\
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\43\ Lorne & Callcott, supra note 19, at 1303-04; Pitt &
Shapiro, supra note 20, 7 Yale J. on Reg. at 174; see also Freeman,
supra note 25, 36 Bus. Law. at 1792.
\44\ William R. Carter, 47 S.E.C. 471, 511-12 (1981); Lorne &
Callcott, supra note 19, at 1303-04 (referring to a speech given by
the Commission's then-General Counsel: Edward Greene, Lawyer
Disciplinary Proceedings Before the Securities and Exchange
Commission, [1981-1982 Transfer Binder] Fed. Sec. L. Rep. (CCH)
para. 83,089, at 84,800 (Jan. 13, 1982)). In 1988, the Commission
ratified Mr. Greene's speech in a release that stated: ``the
Commission, as a matter of policy, generally refrains from using its
administrative forum to conduct de novo determinations of
professional obligations of attorneys.'' Disciplinary Proceedings
Involving Professionals Appearing or Practicing Before the
Commission, Securities Act Release No. 6783, 53 Fed. Reg. 26,427,
26,431 n.30, 1988 WL 278442 (F.R.) (July 13, 1988); see also id.
(referring to Commission practice of generally instituting Rule
102(e) proceedings ``only where the attorney's conduct has already
provided the basis for a judicial or administrative order finding a
securities law violation in a non-Rule 2(e) proceeding'').
\45\ Pitt & Shapiro, supra note 20, 7 Yale J. on Reg. at 174.
---------------------------------------------------------------------------
In the late 1980's, however, Rule 102(e) actions against
accountants became more of a focal point for the Commission.\46\ In
1988, the Commission amended Rule 102(e) to create a presumption that
disciplinary proceedings would be public rather than private--
previously Rule 102(e) proceedings only became public if sanctions were
imposed.\47\ In addition, as an enforcement adjunct to combat
``financial fraud,'' the Commission stepped up its use of Rule 102(e)
to bring charges of ``improper professional conduct'' against the
auditors of public companies.\48\ It was in this context that the
Commission instituted administrative proceedings under Rule 102(e)
against two accountants, David J. Checkosky and Norman A. Aldrich.\49\
---------------------------------------------------------------------------
\46\ Goelzer & Wyderko, supra note 11, 85 Nw. U.L. Rev. at 653.
\47\ Rule 102(e)(7); see Disciplinary Proceedings Involving
Professionals Appearing or Practicing Before the Commission,
Securities Act Release No. 6783, 53 Fed. Reg. 26,427, 1988 WL 278442
(F.R.) (July 13, 1988).
\48\ Goelzer, supra note 17, 52 Brook. L. Rev. at 1061; see also
infra note 135.
\49\ David J. Checkosky, Order Instituting Private Proceedings,
File No. 3-6776 (Nov. 12, 1987).
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II. The Checkosky Decisions
Checkosky and Aldrich, partners at one of the nation's preeminent
accounting firms, were the engagement partner and audit manager in
connection with audits of the Savin Corporation from 1981 to 1984.\50\
The Commission brought a Rule 102(e) proceeding against them in 1987,
and in 1992 affirmed an ALJ's finding of ``improper professional
conduct.'' \51\ In its initial opinion, the Commission found that
Savin's financial statements were false in that the company improperly
capitalized certain expenses for research and development rather than
recording them in their entirety as expenses in the years incurred.\52\
These violations were based on a finding that the auditors, in
violation of Generally Accepted Auditing Standards (``GAAS''), had
improperly permitted Savin to capitalize these expenditures and falsely
certified that Savin's financial statements set forth its financial
condition in accordance with Generally Accepted Accounting Principles
(``GAAP'').\53\
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\50\ David J. Checkosky, 50 S.E.C. 1180, 1180-81 (1992).
\51\ 50 S.E.C. at 1180-81.
\52\ 50 S.E.C. at 1181.
\53\ 50 S.E.C. at 1181.
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Commissioner Roberts concurred in the majority's finding that
respondents violated GAAS and misapplied GAAP, but dissented from the
finding that these errors amounted to ``improper professional conduct''
under Rule 102(e).\54\ In Commissioner Roberts' view, respondents'
conduct did not provide a sufficient basis for a finding that they
would threaten the Commission's processes.\55\