Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-97-01137/USCOURTS-caDC-97-01137-0/pdf.json

Parties Involved:
Norman A. Aldrich
Petitioner
David J. Checkosky
Petitioner
Securities and Exchange Commission
Respondent

Document Text:

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 18, 1998 Decided March 27, 1998

No. 97-1137

DAVID J. CHECKOSKY AND 

NORMAN A. ALDRICH,

PETITIONERS

v.

SECURITIES AND EXCHANGE COMMISSION,

RESPONDENT

On Petition for Review of an Order of the 

Securities and Exchange Commission

Andrew T. Karron 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 

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Paul Gonson, Solicitor. 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 CFR § 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, ¶ 12 (Fin. 

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Accounting Standards Bd. 1974). But once R&D is complete, 

a company may defer so-called "start-up" costs, see id. at 

¶ 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.2In 1992 the 

Commission affirmed the ALJ's finding that Checkosky and 

__________

1 Rule 2(e)(1) provides:

The Commission may censure a person or deny, temporarily 

or permanently, the privilege of appearing or practicing before 

it in any way to any person who is found by the Commission 

after notice and opportunity for hearing in the matter:

(i) Not to possess the requisite qualifications to represent 

others; or

(ii) To be lacking in character or integrity or to have engaged in unethical or improper professional conduct; or

(iii) To have willfully violated, or willfully aided and abetted 

the violation of any provision of the Federal securities laws 

or the rules and regulations thereunder.

17 CFR § 201.102(e)(1).

2 The regulations define "practicing before the Commission" to 

include "[t]he preparation of any statement, opinion or other paper 

by any attorney, accountant, engineer or other professional or 

expert, filed with the Commission in any registration statement, 

notification, application, report or other document with the consent 

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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) ¶ 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 liabilityor 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

__________

of such attorney, accountant, engineer or other professional or 

expert." 17 CFR § 201.102(f)(2).

3 The Commission never offers its own definition of recklessness, 

preferring to adopt by footnoted reference a characterization we 

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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 

__________

used in a 1992 decision. See 1997 Op. at 63,426 n.23 ("Recklessness 

has been described as 'not merely a form of ordinary negligence; it 

is an extreme departure from the standards of ordinary care, which 

presents a danger of misleading buyers or sellers that is either 

known to the defendant or is so obvious that the actor must have 

been aware of it.' "), quoting SEC v. Steadman, 967 F.2d 636, 641-

42 (D.C. Cir. 1992) (citation and internal quotation marks omitted).

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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),4but 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 accoun-

__________

4

"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." Checkosky I, 23 F.3d at 455 (Silberman, J.), 

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tants 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 suggests by negative 

implication that some innocent, i.e., non-negligent, mistakes 

will be held to transgress the Rule. And the third and fourth 

explicitly reserve authority to penalize even an "isolated" 

deviation from GAAS or GAAP if "serious" enough, though as 

we have noted the relevant characteristics of seriousness are 

nowhere defined.5

Not only does the opinion on remand provide no clear 

mental state standard to govern Rule 2(e)(1)(ii), it seems at 

times almost deliberately obscurantist on the question. For 

example, it observes unhelpfully that "[i]mproper professional 

conduct by accountants encompasses a range of conduct." Id.

at 63,429. Later the Commission cites several cases in which 

it has imposed sanctions for improper professional conduct, 

concluding with the following summary: "While the acts in 

each case demonstrated varying degrees of care or mental 

state, we concluded in each that the accountant had improperly certified that financial statements complied with the applicable auditing requirements and that the resulting financial 

statements could not be relied upon." Id. at 63,430. Howev-

__________

quoting Touche, Ross & Co. v. SEC, 609 F.2d 570, 582 (2d Cir. 

1979).

5 Because one of GAAS's General Standards is that "[d]ue professional care is to be exercised in the performance of the audit and 

the preparation of the report," Codification of Statements on 

Auditing Standards, AU § 150.02 (Am. Inst. of Certified Pub. 

Accountants 1993) (General Standard 3) (cited in Checkosky I, 23 

F.3d at 486 n.26 (Randolph, J.)), any negligent audit violates GAAS. 

But the conversethat all deviations from GAAS are per se negligentmight not be true, nor is it self-evidently true with respect to 

GAAP. The Commission's 1997 opinion sheds no light on the status 

of these non-negligent transgressions vis-à-vis Rule 2(e)(1)(ii).

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er legitimate and, indeed, essential the Commission's concern 

about unreliable financial statements may be, it is no substitute for a clearly delineated standard. Instead, the Commission's statements come close to a self-proclaimed license to 

charge and prove improper professional conduct whenever it 

pleases, constrained only by its own discretion (combined, 

perhaps, with the standards of GAAS and GAAP).

In summary, the Commission's opinion yields no clear and 

coherent standard for violations of Rule 2(e)(1)(ii). Although 

we owe "substantial deference to an agency's interpretation of 

its own regulations," Thomas Jefferson Univ. v. Shalala, 512 

U.S. 504, 512 (1994), we cannot defer to an agency when "we 

are at a loss to know what kind of standard it is applying or 

how it is applying that standard to this record." United Food 

and Commercial Workers International Union v. NLRB, 880 

F.2d 1422, 1435-36 (D.C. Cir. 1989).

Of course the agency was in a bind. On the one hand, 

reliance on negligence had its perils. Judge Silberman had 

noted in Checkosky I that adoption of a negligence standard 

might be ultra vires; given that much of the substantive law 

enforced by the Commission requires a showing of scienter, 

use of a negligence standard to penalize professionals might 

be viewed as a back-door expansion of its regulatory oversight powers. See Checkosky I, 23 F.3d at 459 (Silberman, 

J.).6 On the other hand a recklessness standard brought its 

own risks: there might not be substantial evidence to support 

a finding of reckless conduct.7 Nevertheless the Commission 

__________

6 Petitioners also argue that insofar as the Commission has 

embraced a negligence standard, it has failed to distinguish adequately several of its own precedents which seem to require some 

form of scienter, despite being directed by this court to do so on 

remand. See Checkosky I, 23 F.3d at 458-59 (Silberman, J.); id. at 

483-87 (Randolph, J.). Because we find that the Commission's 

opinion on remand fails to embrace a discernable standard, we 

express no opinion on its attempt to distinguish its precedents.

7 Petitioners also argue that because recklessness was not relied 

on by the ALJ in the original proceeding, it could not fairly be 

"raised" for the first time by the full Commission. Although we 

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had to make a choice. There is no justification for the 

government depriving citizens of the opportunity to practice 

their profession without revealing the standard they have 

been found to violate. And, indeed, there is no reason for us 

to address the issues (whether of a legal or factual character) 

raised by each of the hypothetical stances that the Commission might have adopted.

When an agency utterly fails to provide a standard for its 

decision, it runs afoul of more than one provision of the 

Administrative Procedure Act. As Judge Silberman noted in 

the first appearance of this case before us, we have held on 

occasion that an "agency's failure to state its reasoning or to 

adopt an intelligible decisional standard is so glaring that we 

can declare with confidence that the agency action was arbitrary and capricious." Checkosky I, 23 F.3d at 463 (Silberman, J.). In addition, an agency violates the APA when it 

fails to include in its adjudicatory decision a meaningful 

"statement of findings and conclusions, and the reasons or 

basis therefor, on all the material issues of fact, law, or 

discretion presented on the record." 5 U.S.C. § 557(c)(3)(A). 

On at least these criteria, the Commission has defaulted.

There remains the question of remedy. In Greyhound 

Corp. v. ICC, 668 F.2d 1354 (D.C. Cir. 1981), we found for the 

second time that the Interstate Commerce Commission had 

failed to adequately justify its decision to maintain securities 

jurisdiction over the Greyhound holding company in light of 

ICC precedents that seemed to preclude such a ruling. In 

the second go-round, we noted that eight years had passed 

since Greyhound first requested relief from the agency. "The 

Commission," we concluded, "has had ample time and opportunity to provide a reasoned explanation of the decision to 

continue the exercise of its securities jurisdiction. We find no 

useful purpose to be served by allowing the Commission 

another shot at the target." Id. at 1364.

__________

share Judge Silberman's skepticism about this argument, see 

Checkosky I, 23 F.3d at 460-62 (Silberman, J.), the Commission's 

rejection of a recklessness standard moots the point.

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It is true, as then-Judge Thomas pointed out in a concurring opinion in 1991, that application of the Greyhound remedy ought to be "reserved for truly extraordinary situations," 

since "legitimate concerns about judicial overreaching always 

militate in favor of affording the agency just one more chance 

to explain its decision." Tennessee Gas Pipeline Co. v. 

FERC, 926 F.2d 1206, 1214 (D.C. Cir. 1991) (Thomas, J., 

concurring). Our use of the device has indeed been maximally sparingJudge Thomas could not find a case in which we 

had applied it in the decade between Greyhound and Tennessee Gas Pipeline, and we have not found an example from the 

seven years since that decision. The case has, however, been 

followed in the Third Circuit. In Marshall v. Lansing, 839 

F.2d 933 (3d Cir. 1988), that court upheld a district court 

order requiring the Parole Commission to recategorize a 

prisoner's offense as involving less than a kilogram of cocaine, 

after the Commission on remand had failed to offer an 

acceptable basis for its contrary finding: "When a court has 

already remanded a case to an administrative agency for 

failure to explain adequately its decision, and the agency, on 

remand, again fails to provide a reasoned basis for its conclusions, a reviewing court can set aside the agency's decision...." Id. at 945 (citing Greyhound).

This case presents the sort of extraordinary situation for 

which application of Greyhound is reserved. The disciplinary 

proceeding has dragged on for more than ten years. It is 

based on events that occurred as long ago as 1980. Our 1994 

decision set the Commission a straightforward task: to 

"choose its standard and forthrightly apply it to this case." 

Checkosky I, 23 F.3d at 462 (Silberman, J.). It has signally 

failed to do so.

Moreover, there are strong signs that the Commission is 

unlikely to settle on a uniform theory as to the necessary 

mental state for a violation of Rule 2(e)(1)(ii) anytime soon. 

In In re Robert D. Potts, 7 Fed.Sec.L.Rep. (CCH) ¶ 74,479, at 

63,597 (Sept. 24, 1997), two Commissioners found that a 

concurring partner in an accounting firm had violated Rule 

2(e)(1)(ii) by failing to comply with GAAS and representing 

that his client's financial statements accorded with GAAP. 

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Id. at 63,604 & n.40. Because these two Commissioners 

found the accountant's conduct reckless, they declined to 

address whether mere negligence can constitute improper 

professional conduct under Rule 2(e)(1)(ii). Id. at 63,605 n.44. 

In his concurrence, Commissioner Johnsonwho dissented 

from the 1997 Checkosky opinionagreed that Potts had 

acted recklessly but expressly stated his view that scienter 

was required to establish a violation of Rule 2(e)(1)(ii). Id. at 

63,608 & n.1. In dissent, Commissioner Wallmanwho did 

not participate in Checkoskyexpressed the view that a 

charge of improper professional conduct cannot be based on 

"mere negligence." Id. at 63,609-13. Of course, a decision 

such as Potts, issued after the one under review, cannot be 

cited in support of a claim that the one being reviewed is 

inconsistent with agency precedent. See, e.g., MacLeod v. 

ICC, 54 F.3d 888, 892 (D.C. Cir. 1995). But we can take 

judicial notice of it to gauge the futility of allowing the 

current proceedings to drag on into another round in the 

hope that the Commission will do what it should have done in 

each of the earlier rounds. Cf. Oil, Chemical and Atomic 

Workers Int'l Union v. NLRB, 46 F.3d 82, 92-93 (D.C. Cir. 

1995) (refusing to sustain agency action where there is no 

sustainable view, or set of views, supported by a majority of 

the agency). In view of the Commission's repeated failure to 

articulate a discernible standard for violations of Rule 

2(e)(1)(ii), the extraordinary duration of these proceedings, 

and the apparent unlikelihood of a clear resolution on remand, we conclude that it would be futile to allow the SEC a 

third "shot at the target." Greyhound, 668 F.2d at 1364.

The case is remanded with instructions to dismiss the 

charge against petitioners. 

So ordered.

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KAREN LECRAFT HENDERSON, Circuit Judge, concurring:

I concur in the majority opinion but do not agree with the 

discussion on pages 8-9 of the opinion incorporating dictum 

from Checkosky I that the Securities and Exchange Commission may lack the authority to ensure that the professionals 

who practice before it adhere to minimal levels of competence. I strongly believe that every regulatory body possessesand must possessauthority to maintain the professional 

standards of its practitioners.

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