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United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued May 20, 2004 Decided July 16, 2004
No. 03-1265
MICHAEL J. MARRIE AND BRIAN L. BERRY,
PETITIONERS
v.
SECURITIES AND EXCHANGE COMMISSION,
RESPONDENT
On Petition for Review of an Order of the
Securities and Exchange Commission
Michael F. Perlis argued the cause for petitioners. With
him on the briefs was Wrenn E. Chais.
Michael A. Conley, Attorney, Securities & Exchange Com-
mission, argued the cause for respondent. With him on the
brief were Giovanni P. Prezioso, General Counsel, and Eric
Summergrad, Deputy Solicitor.
Bills of costs must be filed within 14 days after entry of judgment.
The court looks with disfavor upon motions to file bills of costs out
of time.
2
Before: HENDERSON, ROGERS and GARLAND, Circuit Judges.
Opinion for the Court filed by Circuit Judge ROGERS.
ROGERS, Circuit Judge: This appeal challenges an opinion
and order of the Securities and Exchange Commission deny-
ing two certified public accountants the privilege of practicing
before the Commission. It revisits the question of whether
the Commission has articulated a clear standard for a finding
of ‘‘improper professional conduct’’ under Rule 102(e) of its
Rules of Practice, 17 C.F.R. § 201.102(e). We conclude that
the lack of clarity identified in the two Checkosky v. SEC
opinions of the court, 23 F.3d 452 (D.C. Cir. 1994) (‘‘Checko-
sky I’’), and 139 F.3d 221 (D.C. Cir. 1998) (‘‘Checkosky II’’),
was not rectified until Rule 102(e) was amended in 1998. As
amended, Rule 102(e) establishes that one of the mental
states required for a finding of ‘‘improper professional con-
duct,’’ is recklessness, defined as an extreme departure from
the standard of ordinary care for auditors. Although the rule
is clear now, because it was unclear at the time of the
sanctioned conduct in 1994 and the Commission’s application
of the amended Rule is impermissibly retroactive, we grant
the petition for review.
I.
Michael Marrie and Brian Berry, as employees of the
accounting firm, Coopers & Lybrand LLP (‘‘Coopers’’), acted
as engagement partner and manager, respectively, for Coo-
pers’ 1994 audit of California Micro Devices, Inc. (‘‘Cal Mi-
cro’’), which designs, manufactures, and distributes electric
circuits and semiconductors. As engagement partner and
engagement manager, Marrie and Berry were responsible for
ensuring that the 1994 fiscal year audit of Cal Micro was
conducted in accordance with generally accepted auditing
standards (‘‘GAAS’’), and that the financial statements filed
with the Securities and Exchange Commission were in con-
formity with generally accepted accounting principles
(‘‘GAAP’’). They prepared an audit plan and began field
work in July 1994, and on September 29, 1994, filed with the
3
Commission the company’s Form 10–K annual financial re-
port for the fiscal year ending June 30, 1994.
Marrie and Berry conducted the audit against a backdrop
of massive financial reporting fraud by Cal Micro, unknown to
the accountants. The Commission found that in fiscal year
1994, the company fraudulently recognized revenue and re-
ceivables for the sale of unshipped or non-existent products,
even though its stated policy was to recognize revenue for
products only upon shipment to customers; falsified sales
records, invoices, and shipping documents, such as shipping
merchandise to fictitious customers; and improperly over-
stated net assets and income, while understating net loss.
Cal Micro had attempted to make reported revenues as high
as possible in order to maintain the impression of growth
after it had lost one of its major customers, Apple Computer
Inc., which had accounted for 32% of the company’s total
product sales the prior year. To avoid detection for improper
revenue recognition, Cal Micro’s management attempted to
‘‘clean’’ the company’s books before the end of the fiscal year,
informing Marrie and Berry that it had decided to issue
approximately $12 million in credit to ‘‘write off’’ certain
accounts receivable. On August 4, 1994, however, Cal Micro
issued a press release announcing its net income and earnings
for the fourth quarter of 1994, and stated that it was writing
off $8.3 million, not $12 million of accounts receivable, $1.3
million of which was written off as bad debt expense. Be-
cause amounts written off for returned products would be
deducted directly from reported revenues, while amounts
written off as bad debt would be treated as expenses and
would not decrease reported revenues, Cal Micro attempted
to maximize the portion of the write-off allocated to bad debt
expense. Following the August 4, 1994 press release, howev-
er, Cal Micro’s stock price dropped and shareholders brought
a lawsuit alleging accounting improprieties.
Regardless, on August 25, 1994, Marrie and Berry, on
behalf of Coopers, presented their independent accountants’
report addressed to Cal Micro’s shareholders and directors,
stating that Cal Micro’s financial statements complied with
GAAP and that the audit had been conducted in accordance
4
with GAAS. Following an independent investigation, Cal
Micro filed a revised financial report with the Commission on
February 6, 1995, showing a net loss of $15.2 million instead
of earnings of $5 million, total revenue of $30.1 million rather
than the previously reported $45.3 million, accounts receiv-
able of $6.3 million instead of $16.9 million, $5.1 million in
inventories instead of $13.9 million, and net property and
equipment of $7.4 million instead of the previously reported
$10.4 million.
On August 10, 1999, just shy of five years after Marrie and
Berry presented the audit report to Cal Micro’s shareholders,
the Commission, through the Division of Enforcement and
Office of the Chief Accountant, instituted disciplinary pro-
ceedings against Marrie and Berry pursuant to Rules
102(e)(1)(ii) and 102(e)(1)(iv)(A). The Commission alleged
that Marrie and Berry had engaged in improper professional
conduct in that they each ‘‘violated GAAS by failing to
exercise appropriate professional skepticism, obtain sufficient
competent evidential matter, or adequately supervise field
work’’ in connection with three aspects of the 1994 audit: (1)
the write-off of $12 million of accounts receivable; (2) the
confirmation of the accounts receivable; and (3) the account-
ing of the sales returns and allowances for sales returns. The
Commission also claimed that Marrie’s and Berry’s failures to
examine the write-off, to investigate discrepancies in the
confirmation responses, and to analyze Cal Micro’s sales
returns and the adequacy of its allowance for returns, were
‘‘an extreme departure from professional standards.’’ Fur-
ther, according to the Commission, Marrie and Berry were
reckless in ignoring ‘‘unmistakable red flags’’ that indicated
potential accounting irregularities in the areas of revenue
recognition, accounts receivable confirmations, sales returns,
sales cutoff, and cash collections. As a result, the Commis-
sion alleged that Cal Micro’s financial statements for the
fiscal year 1994 were materially false and misleading and
were not prepared in conformity with GAAP.
On September 21, 2001, an administrative law judge
(‘‘ALJ’’) dismissed the charges, finding that Marrie and Berry
had not engaged in improper professional conduct within the
5
meaning of Rule 102(e). The ALJ ruled that reckless conduct
under Rule 102(e)(1)(iv)(A) ‘‘must approximate an actual in-
tent to aid in the fraud being perpetrated by the audited
company,’’ and that the Commission had failed to prove that
Marrie’s and Berry’s conduct had been reckless. In re
Marrie, Initial Decision of the ALJ, Release No. 101, File.
No. 3–9966, at 35, 81 (Sept. 21, 2001)(‘‘In re Marrie I’’). On
July 29, 2003, the Commission reversed the dismissal of the
charges and imposed remedial sanctions barring Marrie and
Berry from practicing before the Commission, subject to Rule
102(e)(5)’s provision for reinstatement. See 17 C.F.R.
§ 201.102(e)(5). In sanctioning Marrie and Berry, the Com-
mission stated that ‘‘[t]he question is not whether an account-
ant recklessly intended to aid in the fraud committed by the
audit client, but rather whether the accountant recklessly
violated applicable professional standards. Recklessness,
then, can be established by a showing of an extreme depar-
ture from the standard of ordinary care for auditors.’’ In re
Marrie, Exchange Act Release No. 48246, 2003 WL 21741785
at *11–*12 (July 29, 2003) (‘‘In re Marrie II’’). According to
the Commission, proof of an actual intent to defraud or assist
in a fraud was not required. Id. at *12. Nor was it neces-
sary to show that the auditor had filed a ‘‘materially’’ mislead-
ing document: ‘‘An auditor who fails to audit properly under
GAAS should not be shielded because the audited financial
statements fortuitously are not materially misleading.’’ Id. at
*13. Finally, the Commission did not consider a good faith
defense. The Commission found that Marrie and Berry
recklessly violated fundamental principles of audit work,
failed to exercise due care and appropriate professional skep-
ticism, and failed to collect sufficient competent evidential
matter to provide a basis for the audit opinion with respect to
Cal Micro’s write-off, accounts receivable, and sales returns.
Id. at *30.
II.
Rule 102(e), 17 C.F.R. § 201.102(e), provides the Commis-
sion with a means to ensure that the professionals on whom it
relies ‘‘perform their tasks diligently and with a reasonable
6
degree of competence.’’ Touche Ross & Co. v. SEC, 609 F.2d
570, 582 (2d Cir. 1979). It is directed at protecting the
integrity of the Commission’s own processes, as well as the
confidence of the investing public in the integrity of the
financial reporting process. Recognizing the particularly im-
portant role played by accountants in preparing and certify-
ing the accuracy of financial statements of public companies
that are so heavily relied upon by the public in making
investment decisions, the Commission, following the court’s
Checkosky opinions, adopted amendments to Rule 102(e) to
specify under what circumstances accountants could be held
liable under the Rule. Prior to the 1998 amendments, Rule
102(e) provided that:
(1) Generally. 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 wilfully violated, or willfully aided and abetted
the violation of any provision of the Federal securities
laws or the rules and regulations thereunder.
17 C.F.R. § 201.102(e)(emphasis added). On June 12, 1998,
in response to the court’s holding in Checkosky II, 139 F.3d at
223, that the Commission had failed to articulate a clear
standard for ‘‘improper professional conduct,’’ the Commis-
sion proposed amendments to Rule 102(e) to set forth catego-
ries of conduct that would constitute ‘‘improper professional
conduct.’’ The amendments provided, among other things,
that a finding of ‘‘improper professional conduct’’ could be
made based on reckless conduct, as defined in the securities
fraud context, see SEC v. Steadman, 967 F.2d 636, 641–42
(D.C. Cir. 1992); Sundstrand Corp. v. Sun Chem. Corp., 553
F.2d 1033, 1045 (7th Cir. 1977), cert. denied, 434 U.S. 875
(1977), but with no accompanying requirement of an actual
intent to defraud. The 1998 amendments, effective Novem-
7
ber 25, 1998, added the language in Rule 102(e)(1)(iv), which
provides:
With respect to persons licensed to practice as account-
ants, ‘improper professional conduct’ under
§ 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 stan-
dards, that indicate a lack of competence to practice
before the Commission.
17 C.F.R. § 201.102(e)(1)(iv)(emphasis added).
Marrie and Berry contend that the Commission impermis-
sibly retroactively applied its ‘‘non-fraud based’’ recklessness
standard to the Rule 102(e) proceedings for conduct occurring
in 1994, and erred in finding recklessness where there was no
knowing violation or intent to defraud. The Commission
responds that retroactivity is not an issue because Rule
102(e)(1)(iv)(A) is consistent with its practice well before the
misconduct at issue, and that in 1998 the Commission simply
codified a standard that had been applied previously. It
maintains that in borrowing the definition of recklessness
from Steadman, 967 F.2d at 641–42, and Sundstrand, 553
F.2d at 1045, it was not required to import into its Rule the
requirement in those cases of actual knowledge of fraud. In
its brief, the Commission states that the applicable profes-
sional standards at issue in the Rule are ‘‘indisputably not
fraud-based.’’ Respondent’s Br. at 25.
A.
The court has engaged in an extended dialogue with the
Commission about its standard for sanctioning professionals
8
for ‘‘improper professional conduct.’’ The court has twice
concluded that the Commission had failed to articulate an
intelligible standard for ‘‘improper professional conduct’’ un-
der Rule 2(e)(1)(ii), the predecessor to Rule 102(e), and had
failed to specify what mental state was required for a viola-
tion of the Rule. In Checkosky I, 23 F.3d at 460–62, where
there was no majority opinion, Judge Silberman, writing
separately, referred to two unreconciled lines of Commission
authority—one based on negligence, the other on reckless-
ness—regarding whether a professional acting in good faith
could be subject to discipline for improper professional con-
duct. The Commission had stated that ‘‘a mental awareness
greater than negligence [wa]s not required,’’ Checkosky I, 23
F.3d at 459, but also ‘‘note[d]’’ that the accountants’ conduct
rose to the level of recklessness. Id. at 460. The judge
concluded it was unclear both whether simple negligence
could constitute a violation of the Rule, and also whether
recklessness meant a ‘‘higher form of ordinary negligence,’’ or
‘‘a lesser form of intent,’’ as defined in Steadman, 967 F.2d at
641–42, and Sundstrand, 553 F.2d at 1045. See Checkosky I,
23 F.3d at 460. Those cases defined recklessness as ‘‘not
merely a heightened form of ordinary negligence,’’ but ‘‘an
extreme departure from the standards of ordinary care, TTT
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.’’ Steadman, 967 F.2d at
641–42 (citations omitted); Sundstrand, 553 F.2d at 1045. In
Steadman, the court stated that this type of recklessness was
‘‘a lesser form of intent.’’ Steadman, 967 F.2d at 642 (quot-
ing Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th
Cir. 1977)).
Judge Randolph, by contrast, concluded that there was no
ambiguity with regard to the Commission’s finding that negli-
gence sufficed for a violation of Rule 2(e)(1)(ii), id. at 480, but
that the Commission had failed adequately to justify its ruling
that accountants could be suspended from practice under
Rule 2(e)(1)(ii) without any proof of an intent to defraud or
bad faith. Id. at 479. Referring to the Commission’s deci-
sion in In re Carter, [1981 Transfer Binder] Fed. Sec. L. Rep.
9
(CCH) ¶ 82,847 (Feb. 28, 1981), involving a Rule 2(e) proceed-
ing against lawyers, he concluded that the Commission had
failed adequately to justify why auditors, but not lawyers,
could be found to have engaged in ‘‘improper professional
conduct’’ without proof of an intent to defraud. Id. at 483–85.
As the language of Rule 2(e)(1)(ii) drew no distinction be-
tween professionals, applying to ‘‘any person’’ who practices
before the Commission, id. at 485, and the definitions from
the federal securities laws did not make culpability turn on
the nature of the professional, id. at 486, he reasoned that the
Commission was obligated in changing course to supply a
reasoned analysis, which it had failed to do. See id. at 487.
Because he concluded that the Commission had acted arbi-
trarily and capriciously, vacation of the Commission’s order
was required in his view rather than the simple remand to the
Commission that was favored by Judge Silberman and
adopted by the court. Id. at 454, 467.
On remand the Commission provided a further explanation,
then affirmed the suspension of the accountants. But, in
Checkosky II, 139 F.3d at 226, the court concluded that the
Commission had still failed to provide ‘‘a uniform theory as to
the necessary mental state for a violation of Rule 2(e)(1)(ii).’’
In the court’s view, the Commission on remand had simulta-
neously embraced and rejected standards of recklessness,
negligence, and strict liability, with no guidance as to which
standard it had relied upon in finding a violation of the Rule.
Id. at 223. Although the Commission first appeared to rely
on a theory of recklessness, it proceeded to state that it was
treating recklessness as relevant only to the sanction, that
Rule 2(e)(1)(ii) did not mandate a particular mental state, and
that negligence could, ‘‘under certain circumstances, consti-
tute improper professional conduct.’’ Id. at 224 (citations
omitted). The Commission did not define those circum-
stances with any degree of specificity, and offered no further
definition of negligence than those deviations from GAAP or
GAAS that ‘‘threaten the integrity of the Commission’s pro-
cesses.’’ Id. This left open the possibility, the court ob-
served, that the standard might not even require a showing of
negligence, for there was no way of knowing in advance what
10
kind of errors — non-negligent, innocent mistakes or isolated,
serious deviations from GAAS or GAAP — would meet this
standard. Id. at 224–25. In addition, the court concluded the
Commission had again failed to articulate a clear standard for
the mental state required to violate Rule 2(e)(1)(ii). Id. at
225. For these reasons, the court observed that ‘‘the Com-
mission’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).’’ Id.
Because of ‘‘strong signs’’ that the Commission was unlikely
to provide a uniform theory ‘‘anytime soon,’’ the court re-
manded with instructions to dismiss the charge. Id. at 226–
27.
B.
Congress has codified Rule 102(e)(1) as amended in 1998 in
the Sarbanes–Oxley Act of 2002, 15 U.S.C. § 78d–3, and we
begin with the observation that in the amended Rule 102(e),
the Commission has cured the defects identified in Checkosky
I and II. Absent such a conclusion, there would be no need
to address Marrie’s and Berry’s retroactivity contentions for,
once again, the Rule would be unclear.
The amended Rule clearly sets out the standard for when
an accountant is deemed to have engaged in ‘‘improper pro-
fessional conduct.’’ It provides that ‘‘improper professional
conduct’’ means ‘‘[i]ntentional or knowing conduct, including
reckless conduct that results in a violation of applicable
standards.’’ 17 C.F.R. § 201.102(e)(1)(iv)(A). It also identi-
fies two types of negligent conduct that would warrant sanc-
tions. Id. § 201.102(e)(1)(B). In its accompanying explana-
tion of the amended Rule, the Commission stated that ‘‘for
purposes of consistency under the federal securities laws,’’ it
was adopting the Sundstrand/Steadman definition of reck-
lessness used for substantive violations of the securities laws.
Amendments to Rule 102(e) of the Commission’s Rules of
Practice, Fed. Sec. L. Rep. (CCH) ¶ 86,052, at 80,844 (Oct. 19,
1998) (‘‘Adopting Release’’). Thus, recklessness means ‘‘not
merely a heightened form of ordinary negligence,’’ but ‘‘an
11
extreme departure from the standards of ordinary care, TTT
which presents a danger of misleading buyers or sellers that
is either known to the (actor) or is so obvious that the actor
must have been aware of it.’’ Id. The Commission added,
‘‘This recklessness standard is a lesser form of intent.’’ Id.
However, it emphasized that the standards for finding a
violation of professional conduct were ‘‘not fraud based,’’ id.,
indicating that the elements for violations of professional
practice would not be identical to that of the federal securities
laws. In explaining the amended Rule, the Commission also
rejected suggestions that filing a materially false or mislead-
ing document should be a threshold requirement for a finding
of improper professional conduct, concluding that, ‘‘[a]n audi-
tor who fails to audit properly under GAAS TTT should not be
shielded because the audited financial statements fortuitously
turn out to be accurate or not materially misleading.’’ Id. at
80,847. Finally, the Commission stated that good faith, al-
though it may remain relevant in determining the appropriate
sanction, would not be a defense to reckless conduct, because
good faith would be ‘‘inconsistent with a finding of knowing or
intentional, including reckless, conduct.’’ Id. at 80,849.
Thus, as of November 25, 1998, when the amendments took
effect, the Commission provided a uniform theory of the
necessary mental state required for a finding of improper
professional conduct, see Checkosky II, 139 F.3d at 225,
defined recklessness, and specified the types of negligent
conduct that would result in a violation of the Rule. See
Checkosky I, 23 F.3d at 459–60 (Silberman, J.). Further, in
amending the Rule, the Commission’s accompanying state-
ment eliminated any lack of clarity as to good faith created by
its precedents. See, e.g., Checkosky I, 23 F.3d at 458 (Silber-
man, J.).
The language and history of the amended Rule support the
Commission’s interpretation that ‘‘recklessness’’ under that
Rule can be demonstrated simply by evidence of ‘‘an extreme
departure from the standard of ordinary care for auditors.’’
In re Marrie II, at *14. In this case, the Commission
explained that ‘‘[a]dherence to applicable professional audit-
ing standards protects the Commission’s processes regardless
12
of whether a fraud has been committed.’’ Id. The Commis-
sion further explained in In re Marrie II that ‘‘[r]equiring
proof of a mental state approximating an actual intent to aid
in the fraud committed by the audited company would conflict
with this purpose and fail to protect the Commission’s pro-
cesses from accountants who lack competence to appear
before it.’’ Id. The Commission reasoned that a non-fraud
based standard was warranted given the heavy reliance that
it and the public placed on accountants ‘‘to assure disclosure
of accurate and reliable financial information as required by
the federal securities laws.’’ Id. Although it stated in a
cryptic footnote that the ‘‘concept of materiality’’ continued to
be relevant, see id. at *13 n.18, it explained that the Rule did
not require a showing that the financial statements filed by
the accountants be false or materially misleading, for the
Commission’s concern was to protect the integrity of its
processes and investor confidence in its markets. Id. at *12–
*13. Thus, ‘‘[a]n auditor who fails to audit properly under
GAAS should not be shielded because the audited financial
statements fortuitously are not materially misleading. An
auditor who skips procedures designed to test a company’s
reports or looks the other way despite suspicions is a threat
to the Commission’s processes.’’ Id. at *13.
The 1998 amendments reflect choices that the Commission
was authorized to make in promulgating its Rule, and Marrie
and Berry do not contend to the contrary. Instead, they
contend that the Commission took ‘‘diametrically opposite
positions’’ in explaining the 1998 amendments and in its
holding in their case. They proceed on the basis that the
Commission’s adoption of the Sundstrand/Steadman defini-
tion of recklessness also required inclusion of a fraud element.
But, in contending that they could not be found culpable
absent a finding of conscious or deliberate conduct, which the
Commission conceded was lacking, their premise is faulty.
The Commission’s authority to discipline professionals has
long been distinguished from the execution of its substantive
enforcement functions. See Touche Ross, 609 F.2d at 579.
Marrie and Berry proceed under the erroneous assumption
that because the Commission borrowed the definition of reck-
13
lessness used in substantive anti-fraud provisions, it also was
required to adopt other elements of a securities fraud viola-
tion into Rule 102(e)(1)(iv)(A), such as the requirements of an
intent to defraud and materiality. As explained in Checkosky
I, however, Rule 2(e), the predecessor to Rule 102(e), was
‘‘analytically distinct from substantive provisions of the secu-
rities laws,’’ and cases such as Steadman, 967 F.2d at 641–42,
which involved those provisions, were not determinative in
the analysis of whether improper professional conduct had
occurred. See Checkosky I, 23 F.3d at 456 (Silberman, J.).
Their contention, therefore, that recklessness must involve
deliberate or conscious conduct by an auditor, fails to appreci-
ate that the Sundstrand/Steadman line of cases addressed
violations of Section 10(b) of the Securities and Exchange Act
and Rule 10b–5 that were targeted specifically at securities
fraud. Here, the Commission did not, and did not need to,
charge fraud or aiding and abetting the fraud of Cal Micro,
but instead charged Marrie and Berry on the basis of formu-
lated standards of professional practice designed to protect
the Commission’s processes.
No more problematic is Marrie’s and Berry’s contention
that the amended Rule is arbitrary and capricious, see 5
U.S.C. § 706, or unconstitutionally vague, see Gates & Fox
Co. v. Occupational Safety & Health Review Comm’n, 790
F.2d 154, 156–57 (D.C. Cir. 1986), by failing to provide fair
warning of the conduct it prohibits or requires, and by
incorporating an elastic concept of recklessness that opens
the door to second-guessing of accountants’ judgment calls.
Because of ‘‘[t]he complexity of [GAAP] and [GAAS],’’ see
Checkosky I, 23 F.3d at 479 (Randolph, J.) (quoting James F.
Strother, The Establishment of Generally Accepted Account-
ing Principles and Generally Accepted Auditing Standards,
28 Vand. L. Rev. 201, 203 (1975)), calling for ‘‘[j]udgments [to]
be made about specific transactions’’ about which auditors
could disagree, defining ‘‘recklessness’’ in the context of au-
dits entails obvious difficulties. See id. (citing Jerry Sullivan
et al., Montgomery’s Auditing 19 (10th ed. 1985)). In the
1998 amendments, however, the Commission has specified the
applicable intent standard and has limited the occasions
14
where it will find sanctionable conduct to ‘‘extreme depar-
ture[s]’’ from professional standards that demonstrate that an
accountant lacks competence to practice before the Commis-
sion. Adopting Release, at 80,844. It cannot be gainsaid that
the Commission could reasonably conclude that any licensed
accountant is on notice of professional standards generally
and of what constitutes extreme departures in particular.
For this reason, professional disciplinary Rules have with-
stood vagueness challenges. See, e.g., United States v.
Hearst, 638 F.2d 1190, 1197 (9th Cir. 1980). The duties to
exercise due care, see American Institute of Certified Public
Accountants (‘‘AICPA’’), Codification of Statements on Au-
diting Standards, AU § 230.02, to obtain sufficient evidential
matter, see id. AU § 150.02, and to exercise professional
skepticism, see id. AU § 316.16, are ‘‘standards to which all
accountants must adhere.’’ Potts v. SEC, 151 F.3d 810, 813
(8th Cir. 1998). See In re Potts, 53 S.E.C. 187, 196–97 (Sept.
24, 1997); see also Ponce v. SEC, 345 F.3d 722, 739 (9th Cir.
2003); Checkosky I, 23 F.3d at 472 (Randolph, J.). Rule 202
of AICPA’s Code of Professional Conduct recognizes the
Codification of Statements on Auditing Standards as an
interpretation of GAAS. As the Commission explained in the
instant case, professional misconduct constituting an extreme
departure occurs, for instance, when an auditor ‘‘skips proce-
dures designed to test a company’s reports or looks the other
way despite suspicions.’’ In re Marrie II, at *13. The
Commission’s standard for recklessness, then, as guided and
limited by generally accepted standards of the profession,
does not entail arbitrary subjective second-guessing of audit-
ing judgment calls.
To the extent that Marrie and Berry point out that GAAS
did not ‘‘technically’’ require them to audit the write-off, they
miss the point. The Commission did not fault them for failing
to audit the write-off, but with failing to exercise the requisite
professional skepticism. The Commission concluded that the
necessary professional skepticism was lacking because they
failed to follow up on their own request that Cal Micro
provide a documented analysis of the $12 million write-off,
even though they were well aware that the write-off was
15
unusually large and had occurred near the end of the fiscal
year. Under GAAS, accountants must test ‘‘transactions that
are both large and unusual, particularly at year-end.’’ AIC-
PA, AU § 316.20. As certified public accountants, Marrie
and Berry were deemed to understand the need to obtain
adequate documentation to support a write-off of such a
staggering amount, and, indeed, their call for documentation
evinced an appreciation of what was required of them in
conducting the audit. Under the circumstances, the Commis-
sion could reasonably conclude that their failure to obtain the
necessary documentation was an extreme departure from
professional standards.
For these reasons, we conclude Marrie and Berry have
failed to show that the Commission’s amended Rule is arbi-
trary or capricious or unconstitutionally vague.
C.
Turning to the Commission’s application of amended Rule
102(e) in this case, we hold, in light of Checkosky I and II,
that the Commission erred in applying its non-fraud Rule
retroactively, for there was no ‘‘ascertainably certain’’ stan-
dard for finding ‘‘improper professional conduct’’ under Rule
102(e) in the summer of 1994 when Marrie and Berry audited
Cal Micro. See General Elec. Co. v. EPA, 53 F.3d 1324, 1330
(D.C. Cir. 1995). Fair notice of the standards against which
one is to be judged is a fundamental norm of administrative
law: ‘‘[t]here 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.’’
Checkosky II, 139 F.3d at 225–26. ‘‘Given the enormous
impact on accountants TTT that the Rule has, and in fairness
to petitioners, the Commission must be precise in declaring
the standard against which petitioners’ conduct is measured.’’
Checkosky I, 23 F.3d at 462 (Silberman, J.). See id. at 479
(Randolph, J.); see also Checkosky II, 139 F.3d at 227. As
late as March 27, 1998, when Checkosky II was decided, the
court concluded that the Commission had failed to articulate
an intelligible standard for what constituted ‘‘improper pro-
16
fessional conduct,’’ and had failed to specify the state of mind
necessary for a violation of the Rule. Marrie and Berry,
therefore, were not on notice in the summer 1994 either of
the contours of the Commission’s recklessness standard or
that they could be barred from practice before the Commis-
sion without proof of intent to defraud or lack of good faith.
While the Commission maintains that as certified public
accountants, Marrie and Berry knew that they would be held
to certain professional standards, such as GAAS and GAAP,
this was no less true for the petitioners in Checkosky I and II,
whom the court determined were nevertheless entitled to
more specific guidance as to the Commission’s interpretation
of the Rule.
Further, we cannot agree with the Commission that it did
not retroactively apply a new recklessness standard. In
Landgraf v. USI Film Products, 511 U.S. 244, 269 (1994), the
Supreme Court set out the standard for retroactivity. A
statute is not retroactive merely because it is applied in ‘‘a
case arising from conduct antedating the statute’s enact-
ment;’’ rather, the operative inquiry is ‘‘whether the new
provision attaches new legal consequences to events complet-
ed before its enactment.’’ Id. at 269–70. The Court observed
that ‘‘familiar considerations of fair notice, reasonable reli-
ance, and settled expectations’’ should offer guidance in those
hard cases where a finding of retroactivity requires balancing
‘‘the nature and extent of the change in the law and the
degree of connection between the operation of the new rule
and a relevant past event.’’ Id. at 270. In the administrative
context, this court in National Mining Association v. Depart-
ment of Labor, 292 F.3d 849, 859 (D.C. Cir. 2002), held that ‘‘a
rule is retroactive if it ‘takes away or impairs vested rights
acquired under existing law, or creates a new obligation,
imposes a new duty, or attaches a new disability in respect to
transactions or considerations already past.’ ’’ (quoting Ass’n
of Accredited Cosmetology Sch. v. Alexander, 979 F.2d 859,
864 (D.C. Cir. 1992)).
In applying the amended Rule 102(e) to Marrie’s and
Berry’s conduct in 1994, the Commission has imposed new
legal consequences and new legal duties: the elimination of
17
the good faith defense and of the requirement that materiali-
ty be proved by showing that a false or misleading financial
statement had been filed. Prior to the 1998 amendments, the
court concluded it was unclear whether good faith could be a
defense to recklessness or a finding of improper professional
conduct, as evidenced by conflicting lines of Commission
precedents. See Checkosky I, 23 F.3d at 458 (Silberman, J.).
Several Commission opinions suggested that absent knowing
conduct, good faith was a defense to recklessness. For
instance, in In re Logan, 10 S.E.C. 982 (1942), the Commis-
sion indicated in dictum that good faith was a defense, and in
In re Carter, [1981 Transfer Binder] Fed. Sec. L. Rep. (CCH)
¶ 82,847, at 84, 145 (Feb. 28, 1981), the Commission stated
that lawyers ‘‘acting in good faith and exerting reasonable
efforts to prevent violations of the law’’ could not be held
liable for violation of Rule 2(e)(1)(ii). However, in In re
Haskins & Sells, Accounting Series Releases No. 73, [1937–
1982 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 72,092, at
62,197 (Oct. 30, 1952), the Commission stated that good faith
was not a defense, at least for auditors, to a Rule 2(e)
proceeding. See also In re Schulzetenberg, Admin. Proc. 3–
6881, slip op. at 2 (Nov. 10, 1987) (unpublished) (same). But
see Checkosky I, 23 F.3d at 459 (Silberman, J.), 482 (Ran-
dolph, J.).
Given Commission precedent and our own, the Commis-
sion’s statement in adopting the 1998 amendment to Rule
102(e) that good faith was not a defense, see Rule 102(e)(1)(ii),
and that ‘‘[s]ubjective good faith is inconsistent with a finding
of knowing or intentional, including reckless, conduct,’’ Adopt-
ing Release, at 80,849, imposed new legal consequences. At
the time of the 1994 audit, Marrie and Berry did not have fair
notice that they could be sanctioned for improper professional
conduct even if they had been acting in good faith. In view of
the Commission’s prior opinions and, even assuming they
predicted the Commission would adopt the Sundst-
rand/Steadman recklessness standard, they had reason to
believe that recklessness required proof of either an intent to
defraud or a reckless disregard of their legal obligations. See
Steadman, 967 F.2d at 641–42. Indeed, the ALJ interpreted
18
the Sundstrand/Steadman recklessness standard, as adopted
by the Commission for Rule 102(e) violations, to include a
requirement of an actual intent to defraud.
The Commission also changed the legal landscape in apply-
ing the amended definition of recklessness to Marrie’s and
Berry’s conduct in 1994 when it altered the element of
materiality. The Rule, as it is now interpreted, does not
require a showing of false or misleading financial statements.
In maintaining that it had always abided by the Sundst-
rand/Steadman definition of recklessness, see Respondent’s
Br. at 34, the Commission was bound to apply the materiality
requirements of those cases or make clear that it was adopt-
ing a different requirement. The court in Sundstrand, 553
F.2d at 1045, held that reckless omissions of material facts
upon which others had placed ‘‘justifiable reliance’’ would
result in liability under the securities laws. Id. at 1044. See
also Steadman, 967 F.2d at 640–41. In the securities fraud
context, an omission was defined as material ‘‘if there was a
substantial likelihood that a reasonable shareholder would
consider it important in deciding how to vote.’’ Basic Inc. v.
Levinson, 485 U.S. 224, 231 (1988) (quoting TSC Industries,
Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). In the
instant case, however, the Commission stated that reckless-
ness could be found without a finding of this type of materiali-
ty, namely, the filing of ‘‘false financial statements’’ and
financial statements that contain a ‘‘material misstatement.’’
In re Marrie II, at *13. Until the 1998 amendments to Rule
102(e), the Commission had not clarified that this type of
materiality would no longer be required to find recklessness
under Rule 102(e), and Marrie and Berry could not be held to
have known of the change at the time of the audit.
Notwithstanding these altered requirements for proving
unprofessional conduct as a result of recklessness, the Com-
mission contends that the amended Rule is not impermissibly
retroactive because it ‘‘is substantively consistent with prior
regulations or prior agency practices, and has been accepted
by all Courts of Appeals to consider the issue.’’ Nat’l Min-
ing, 292 F.3d at 860. There are several problems with the
Commission’s position. First, its statement is untrue because
19
it ignores this court’s Checkosky opinions, which declared the
Commission’s earlier approach too unclear to enforce. The
Commission’s related contention that, even absent the altered
requirements of the amended Rule, Marrie and Berry could
have been sanctioned because the Commission found both
that they had acted with a lesser form of intent and that they
cannot have acted in good faith, see In re Marrie II at *11;
Adopting Release, at 80,849, simply repeats the Commission’s
claim that the type of reckless misconduct engaged in by
Marrie and Berry had always been a basis for discipline
under Rule 102(e) and its predecessors. Yet, prior to the
amended Rule, the court in Checkosky I and II determined
that the Commission had not been ‘‘precise in declaring the
standard against which [accountants’] conduct is measured.’’
Checkosky I, 23 F.3d at 462 (Silberman, J.); see also Checko-
sky II, 139 F.3d at 227.
Second, the cases cited in the Commission’s opinion for the
proposition that the amended Rule 102(e) simply codified its
longstanding use of the recklessness standard were decided
after Marrie’s and Berry’s sanctioned conduct. See, e.g., In
re Ponce, Exchange Act Release No. 43235 (Aug. 31, 2000), 73
S.E.C. Dkt. 442, 465 n.52, aff’d, 345 F.3d at 741–42. The one
exception, In re Jackson, 48 S.E.C. 435 (Jan. 21, 1986),
neither defined recklessness nor specified the standard for
finding a violation of applicable professional standards, and, in
any event, was applying a rule that the court in Checkosky I
and II concluded failed to give fair notice. While in 1997 the
Commission in In re Potts, 53 S.E.C. at 204 n.40, applied the
same Sundstrand/Steadman definition of recklessness as
adopted by the Commission in the amended Rule 102(e) and,
by its opinion, gave notice that a finding of recklessness could
be made without a finding of fraudulent intent, its opinion
postdated by three years Marrie’s and Berry’s sanctioned
conduct and the filing of their Form 10–K report to the
Commission. Moreover, the court in Checkosky II, 139 F.3d
at 226, observed that even in Potts, the Commission failed ‘‘to
settle on a uniform theory as to the necessary mental state
for a violation of [the] Rule’’ (referring to Rule 102(e)’s
predecessor). In addition, in Potts, although the Commission
20
discussed an auditor’s duties under GAAS to determine
whether financial statements contained material misstate-
ments, see 53 S.E.C. at 196–97, it failed to clarify whether, by
adopting the Sundstrand/Steadman definition of reckless-
ness, it was also adopting the element of materiality required
in the securities fraud context.
The court is constrained to hold, in light of Checkosky I and
II, that regardless of whether the evidence showed that
Marrie’s and Berry’s conduct in auditing Cal Micro was
reckless under Rule 102(e) because it involved extreme depar-
tures in professional standards, the Commission’s reckless-
ness standard was unclear in the summer 1994 when Marrie
and Berry conducted the audit. Although the 1998 amend-
ments to Rule 102(e) rectified the lack of clarity identified in
Checkosky I and II, application of the amended Rule, which
changed the legal landscape with respect to the standard for
finding ‘‘improper professional conduct,’’ to conduct in 1994
was impermissibly retroactive. Accordingly, we grant the
petition and reverse the Commission’s opinion and order of
July 29, 2003, without reaching the other challenges in the
petition for review.