Checkosky v. Securities & Exchange Commission

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

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 en-
gaged in "improper professional conduct" in violation of the
Commission's Rule 2(e)(1)(ii), 17 CFR s 201.102(e)(1)(ii). Af-
ter review in this court we remanded the case to the Commis-
sion, 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 devel-
opment must be expensed immediately rather than deferred.
See Accounting For Research and Development Costs, State-
ment of Financial Accounting Standards No. 2, p 12 (Fin.

Accounting Standards Bd. 1974). But once R&D is complete,
a company may defer so-called "start-up" costs, see id. at
p 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 gener-
ally accepted auditing standards ("GAAS").

The Commission initiated disciplinary proceedings against
Checkosky and Aldrich in 1987, charging that the two accoun-
tants 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.2 In 1992 the
Commission affirmed the ALJ's finding that Checkosky and

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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 en-
gaged 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 s 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

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 interpreta-
tion 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) p 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 liability--or 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 profes-
sional 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

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of such attorney, accountant, engineer or other professional or
expert." 17 CFR s 201.102(f)(2).

3 The Commission never offers its own definition of recklessness,
preferring to adopt by footnoted reference a characterization we

But after devoting several pages to an attempt to demon-
strate petitioners' recklessness, the opinion abruptly for-
swears any reliance on that concept as an element of improp-
er 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 con-
duct." Id. at 63,430.

On review the Commission adhered to the second of these
positions, disavowing any suggestion that recklessness is nec-
essary 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 Respon-
dent at 49. Thus, although in fact the 1997 opinion began
with a consideration of petitioners' mental state, the Commis-
sion'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 stan-
dard. 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 profession-
al conduct." 1997 Op. at 63,430 (emphasis added). Elemen-
tary 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).

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),4 but not as a standard
for determining violations of the rule in disciplinary proceed-
ings. 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 possibili-
ty that a "standard" revolving around perceived danger to
future processes might not even require a showing of negli-
gence:

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 profes-
sional 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-

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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.),

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 disci-
pline.

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 improper-
ly certified that financial statements complied with the appli-
cable 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 profes-
sional care is to be exercised in the performance of the audit and
the preparation of the report," Codification of Statements on
Auditing Standards, AU s 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 converse--that all deviations from GAAS are per se negli-
gent--might 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--vis Rule 2(e)(1)(ii).

er legitimate and, indeed, essential the Commission's concern
about unreliable financial statements may be, it is no substi-
tute for a clearly delineated standard. Instead, the Commis-
sion'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 over-
sight 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

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6 Petitioners also argue that insofar as the Commission has
embraced a negligence standard, it has failed to distinguish ade-
quately 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

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 Commis-
sion 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 arbi-
trary and capricious." Checkosky I, 23 F.3d at 463 (Silber-
man, 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. s 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 oppor-
tunity 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.

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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.

It is true, as then-Judge Thomas pointed out in a concur-
ring opinion in 1991, that application of the Greyhound reme-
dy 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 maximal-
ly sparing--Judge Thomas could not find a case in which we
had applied it in the decade between Greyhound and Tennes-
see 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 conclu-
sions, a reviewing court can set aside the agency's deci-
sion...." 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) p 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.

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 Johnson--who dissented
from the 1997 Checkosky opinion--agreed 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 Wallman--who did
not participate in Checkosky--expressed 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 re-
mand, 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.

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 Commis-
sion may lack the authority to ensure that the professionals
who practice before it adhere to minimal levels of compe-
tence. I strongly believe that every regulatory body possess-
es--and must possess--authority to maintain the professional
standards of its practitioners.