Opinion ID: 3013270
Heading Depth: 2
Heading Rank: 2

Heading: Independent Auditor Verification

Text: In Hudson, the Supreme Court held that a local union representing 27,500 employees and collecting over $4 million in annual dues must provide non-members with “sufficient information to gauge the propriety of the union’s fee.” 475 U.S. at 306. The Court went on to explain that “[t]he Union need not provide nonmembers with an exhaustive and detailed list of all its expenditures, but adequate disclosure surely would include the major categories of expenses, as well as verification by an independent auditor.” Id. at 307 n.18 (emphasis added). We applied Hudson’s independent auditor requirement in Hohe v. Casey, 956 F.2d 399 (3d Cir. 1992), and held that the First Amendment required a state-level exclusive bargaining representative for approximately 54,000 employees to obtain independent auditor verification. Id. at 415-16. We noted that “the purpose of requiring the verification in the [Hudson] notice is to give the nonmembers some prior assurance that the [fair-share] fee was properly calculated,” and “[w]hen nonmembers do not receive that assurance, their constitutional rights are violated under Hudson.” Id. at 415. 8 Today we decide whether Hudson’s independent auditor requirement applies to SAEA, a much smaller union than the unions involved in Hudson and Hohe. Plaintiffs argue that it does. The Unions contend that Hudson’s independent auditor requirement was merely dictum or applies only to large unions, like those in Hudson and Hohe, that can afford an independent auditor. They point out that SAEA would spend more on an audit than it collects through fair-share fees. Moreover, the Unions claim that SAEA’s finances are so simplistic that non-members can obtain “sufficient information,” Hudson, 475 U.S. at 306, by examining its documents themselves. No other circuit has clearly resolved this issue.5 In 5. A state case from Massachusetts, Wareham Education Association v. Labor Relations Commission, 713 N.E.2d 363 (Mass. 1999), squarely addressed the question before us and held that “there is no exception to Hudson’s audit requirement for small local union affiliates.” Id. at 368. Another state-court case, Whitley County Teachers Association v. Bauer, 718 N.E.2d 1181 (Ind. Ct. App. 1999), reached the opposite result, holding that Hudson was not violated when a local union did not obtain an independent audit of its financial records. Id. at 1191-92. In Tierney v. City of Toledo, 824 F.2d 1497 (6th Cir. 1987), the Sixth Circuit wrote that Hudson required “an audited, detailed accounting of local union payments to affiliated state and national labor organizations.” Id. at 1503. However, the Court did not make this statement in the context of a claim that Hudson’s requirements should apply differently to a small local union, as is the case here. The Unions note that, in the NLRB context, some courts have approved what is known as the “local presumption” — an assumption that the percentage of chargeable to nonchargeable expenses will be the same for the local union as for the parent union. See, e.g., Finerty v. NLRB, 113 F.3d 1288, 1292-93 (D.C. Cir. 1997); see also Thomas v. NLRB, 213 F.3d 651, 659-60 (D.C. Cir. 2000); Price v. Int’l Union, United Auto., Aerospace & Agric. Implement Workers of Am., 927 F.2d 88, 93-94 (2d Cir. 1991) (approving use of local presumption). Courts presented with First Amendment questions in the public employer context have not approved of the local presumption, however. See, e.g., Lowary v. Lexington Local Bd. of Educ., 903 F.2d 422, 431 (6th Cir. 1990); Prescott, 177 F.3d at 1108. Whatever the validity of the local presumption, it is irrelevant to the question presented in this case. The local presumption is merely a method for estimating a local union’s ratio of chargeable to nonchargeable expenses. At issue here is whether an auditor must verify 9 Andrews v. Education Association of Cheshire, 829 F.2d 335 (2d Cir. 1987), the Second Circuit concluded that “the procedures mandated by Hudson are to be accorded all nonmembers of agency shops regardless of whether the union believes them to be excessively costly.” Id. at 339. However, the Court limited this broad statement in a footnote, in which it made clear that it was not addressing whether or how Hudson applies to small local unions because the local union there was one of “three interlocking organizations” — the local union, the state union, and the NEA.6 Id. at 340 n.2 (“[The district court’s] opinion implies that Hudson might not require an independent auditor if the union involved were small enough. We need not decide the issue here.”) (internal citation omitted). The Ninth Circuit, in Prescott v. County of El Dorado, 177 F.3d 1102 (9th Cir. 1999), vacated on other grounds, 528 U.S. 1111 (2000), reinstated in relevant part, 204 F.3d 984 (2000), held that, regardless of its accompanying high cost, a state union must conduct a “true audit.” Id. at 1107-08. The Court left unanswered, however, whether the independent auditor requirement applied to a small local union. Id. at 1108. (“We do not decide that each little unit in the [state union] firmament must necessarily be subjected to a separate verified audit of its expenditures . . . .”). In a subsequent case, Harik v. Chicago Teachers Association, 298 F.3d 863 (9th Cir. 2002), the Court held that a small local union must obtain “independent verification” of its expenses, but need not obtain a “formal audit.” Id. at 866. The Harik Court did not discuss precisely what “independent verification” entails and how it differs from the “true audit” Prescott required of larger unions. the total expenses to which that ratio may be applied. See Hohe, 956 F.2d at 410 (in a case in which a union attempted to apply the local presumption, holding disclosure to non-members inadequate because “[t]he notice . . . to nonmembers did not disclose the affiliated locals’ ‘major categories of expenses’ nor was there any assertion that the locals’ categories of expenses mirrored those of [the state union.]”). 6. While Andrews did not provide any basis for us to determine whether the local unions at issue were larger than SAEA, we note that SAEA too is part of “three interlocking organizations” — SAEA, PSEA, and NEA. 10 We hold that every union collecting fair-share fees from non-members must subject its disclosed financial information to independent auditor verification. The Supreme Court’s mandate cannot be bent simply because the cost to the union is great. The Supreme Court implied no intent to make the audit requirement depend on the size of the reporting union. Absent a directive by the Court, we likewise make no exception. But what level of independent auditor verification does Hudson require? Broadly speaking, auditors can provide three different types of accounting services: compilations, reviews, and audits. A compilation is the “lowest level of assurance” regarding an entity’s financial statements. Christian Tregillis, Overview of Services Provided by CPAs, in Basics of Accounting & Finance: What Every Practicing Lawyer Needs to Know 88 (PLI Corp. Law & Practice Course, Handbook Series No. B-1064, 1998). It expresses “neither an opinion nor any level of assurance.” Id. When performing a compilation, an accountant need not “verify or corroborate the financial statement information provided by the client.” Jane Dillard-Eggers, Understanding Compilations, Reviews, and Audits, at http://www.tscpa.com/public/smallbusinessarticles/ understanding_compilations.htm. A review involves an intermediate level of scrutiny in which the auditor provides “limited assurance” on the entity’s financial statements. See id. In so doing, the auditor indicates that he “is not aware of any material modifications needed to be in conformity with [generally accepted accounting principles, also known as GAAP.]” Tregillis, supra, at 88. In order to provide this “limited assurance,” the auditor must make some, but not comprehensive, inquiry into client management, accounting practices, internal control structure, and analytical procedures used by the organization. See Dillard-Eggers, supra. The scope of the “inquiry and analytical procedures are the major difference between a review and a compilation.” Larry P. Bailey, GAAS Guide: A Comprehensive Restatement of Generally Accepted Auditing Standards 16.31 (1994). 11 In an audit, which provides “the highest level of assurance on financial statements,” the accountant “provides verification of the financial statements’ claims and assertions” and expresses an opinion on the entity’s financials. Tregillis, supra, at 85 (emphasis added). Among other procedures, the accountant “consider[s] and evaluate[s] . . . the internal control system of the [client] . . . [and] tests . . . the underlying documentation to support account balances.” Dillard-Eggers, supra; Bailey, supra, at 16.51. Annual audits are required for all publicly traded companies. Tregillis, supra, at 85. As between a review and an audit, “[a] review may bring to the accountant’s attention significant matters affecting the financial statements, but it does not provide assurance that the accountant will become aware of all significant matters that would be disclosed in an audit.” 1 John R. Clay et al., Guide to Compilation and Review Engagements § 101.5 (24th ed. 2002). This is because “a review does not contemplate obtaining an understanding of the internal control structure or assessing control risk; tests of accounting records and of responses to inquiries by obtaining corroborating evidential matter through inspection, observation or confirmation; and certain other procedures ordinarily performed during an audit.” Id. We hold that local unions, regardless of their size, are required to obtain formal audits of their financial statements. Compilations and reviews do not provide an adequate basis for a non-member to decide whether to object to a fair-share fee. See Prescott, 177 F.3d at 1107 (“[A]n audit, as opposed to a review, offers at least some verification of the amounts disclosed in the financial statement. . . . We do not see how a mere review of the union’s records can offer the ‘verification’ that the Supreme Court and we have spoken of.”). Indeed, “verification” — the word used by the Supreme Court in Hudson, 475 U.S. at 307 n.18, and by at least one accounting authority in describing an audit, see Tregillis, supra, at 85 — means authenticating or confirming the truth or accuracy of a statement. Webster’s Third New Int’l Dictionary of the English Language Unabridged 2543 (1971). Put another way, an audit “make[s] assurance double sure.” William 12 Shakespeare, Macbeth act 4, sc. 1, line 96 (W.J. Craig, ed., Oxford 1914). A review — testing merely to be aware of the need for material modifications to financial disclosures — does not.7 We take no position on the precise procedures an accountant must follow when auditing a local union.8 Like the Second Circuit in Andrews, 829 F.2d at 340, and the Sixth Circuit in Gwirtz v. Ohio Education Association, 887 F.2d 678, 680 (6th Cir. 1989), we decline to hold either that an accountant’s procedures must constitute the “least restrictive process imaginable,” Andrews, 829 F.2d at 340, or that local unions must obtain the “ ‘highest’ possible level of audit service,” Gwirtz, 887 F.2d at 680. See generally Prescott, 177 F.3d at 1107 (noting that audits “may vary in procedures and sampling rates”). We do note, however, that Hudson does not require absolute precision. See Hudson, 475 U.S. at 307 n.18 (“We continue to recognize that there are practical reasons why ‘[a]bsolute precision’ in the calculation of the charge to nonmembers 7. We recognize that accountants review rather than audit public corporations’ interim financial statements, D. Edward Martin, Attorney’s Handbook of Accounting, Auditing and Financial Reporting § 13.03[1] (4th ed. 2002), and that investors rely on these unaudited interim financial statements when making investment decisions. Despite this industry practice, we believe that, until the Supreme Court tells otherwise, Hudson forecloses the argument that a review is acceptable in this context. 8. However, we read literally Hudson’s requirement of auditor independence and therefore require that the accountant performing the audit be truly independent of the local union, i.e., not an accountant employed in-house by the union. See Ferriso v. NLRB, 125 F.3d 865, 871-73 (D.C. Cir. 1997) (holding that Hudson requires an auditor to have “independence and qualifications [that] conform to prevailing norms for audits of comparable entities.”). But see Int’l Ass’n of Machinists & Aerospace Workers v. NLRB, 133 F.3d 1012, 1017 (7th Cir. 1998) (Posner, J.) (explicitly declining to follow Ferriso because “ ‘[i]ndependence’ is a slippery term” and cases requiring absolute independence failed to “consider alternatives” and are “in tension with cases . . . that hold that dissenters are not entitled to the highest level of audit services that the market offers”). 13 cannot be ‘expected or required.’ ”) (quoting Allen, 373 U.S. at 122) (alteration in original).9 We recognize that our decision might place high costs on some local unions. However, non-members’ First Amendment freedoms may not be eroded simply because they are costly to enforce. Further, local unions are not without options. For example, unions without the financial wherewithal to afford the Hudson-mandated audit might choose to enter into combinations with other small unions to achieve necessary economies of scale. In the alternative, state or national unions might choose to subsidize the cost of local unions’ audits.