[Federal Register Volume 63, Number 206 (Monday, October 26, 1998)]
[Rules and Regulations]
[Pages 57164-57187]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-28466]



[[Page 57163]]

_______________________________________________________________________

Part II





Securities and Exchange Commission





_______________________________________________________________________



17 CFR Part 201



Amendment to Rule 102(e) of the Commission's Rules of Practice; Final 
Rule

  Federal Register / Vol. 63, No. 206 / Monday, October 26, 1998 / 
Rules and Regulations  

[[Page 57164]]



SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 201

[Release Nos. 33-7593; 34-40567; 35-26929; 39-2369; IA-1771; IC-23489; 
File No. S7-16-98]
RIN 3235-AH47


Amendment to Rule 102(e) of the Commission's Rules of Practice

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
adopting an amendment to Rule 102(e) of the Commission's Rules of 
Practice. Under Rule 102(e), the Commission can censure, suspend or bar 
persons who appear or practice before it. The amendment clarifies the 
Commission's standard for determining when accountants engage in 
``improper professional conduct'' under Rule 102(e)(1)(ii).

EFFECTIVE DATE: The rule amendment will become effective November 25, 
1998.

FOR FURTHER INFORMATION CONTACT: Michael J. Kigin, Associate Chief 
Accountant, Office of the Chief Accountant, at (202) 942-4400; or David 
R. Fredrickson, Assistant General Counsel, Office of the General 
Counsel, at (202) 942-0890.

SUPPLEMENTARY INFORMATION: The Commission today is adopting an 
amendment to Rule 102(e).\1\
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    \1\ 17 CFR 201.102(e).
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I. Executive Summary

    Under Rule 102(e) of the Commission's Rules of Practice, the 
Commission can censure, suspend or bar professionals who appear or 
practice before it.\2\ Today, the Commission is amending Rule 102(e) to 
clarify the Commission's standard for determining when accountants \3\ 
engage in ``improper professional conduct'' under subsection (1)(ii) of 
the rule.
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    \2\ The rule addresses the conduct of attorneys, accountants, 
engineers and other professionals or experts who appear or practice 
before the Commission. 17 CFR 201.102(e)(2) and (f)(2).
    \3\ This clarification addresses the conduct of accountants 
only, and is not meant to address the conduct of lawyers, other 
professionals or experts who practice before the Commission.
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    The Commission's proposal to amend Rule 102(e) was prompted by a 
recent judicial decision by the U.S. Court of Appeals for the District 
of Columbia Circuit concerning the conduct of two accountants. The 
court found that the Commission's opinions in that case had not 
articulated clearly the ``improper professional conduct'' element of 
the rule.\4\ To address the court's concerns, the Commission published 
for comment a proposed amendment to Rule 102(e) on June 18, 1998.\5\ To 
give the public additional time to comment on the proposed amendment, 
the Commission extended the comment period until August 20, 1998.\6\
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    \4\ Checkosky v. SEC, 139 F.3d 221 (D.C. Cir. 1998) (``Checkosky 
II'').
    \5\ Securities Act Release No. 7546 (June 12, 1998), 63 FR 33305 
(June 18, 1998) (the ``Proposing Release''). In addition to 
publishing the Proposing Release in the Federal Register, the 
Commission also posted it on its Website. The address of the 
Commission's Website is http://www.sec.gov.
    \6\ Securities Act Release No. 7555 (July 15, 1998), 63 FR 39054 
(July 21, 1998).
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    The proposed amendment articulated three types of violations of 
applicable professional standards that would constitute ``improper 
professional conduct.'' The final rule amendment changes the focus of 
these provisions from types of violations to types of conduct that 
result in violations of applicable professional standards. Comment 
letters addressing these provisions generally supported two parts of 
the Commission's proposal: one, knowing or intentional conduct, 
including reckless conduct; and, two, repeated instances of 
unreasonable conduct. The Commission adopts these provisions in 
substantially the form they were proposed.
    Rule 102(e) proceedings may also be based on a third type of 
conduct: ``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. This part of the final rule amendment differs from the 
proposed amendment. This provision covers a single instance of serious 
misconduct that may not rise to the level of intentional or knowing 
(including reckless) conduct. The changes from the proposed amendment 
emphasize that this provision applies only to deviations from 
professional standards--greater than ordinary negligence but less than 
recklessness--when an accountant knows or should know of a heightened 
risk. The final rule amendment refers to this situation as ``heightened 
scrutiny.'' The differences between the proposed amendment and the 
final amendment are discussed in detail below.
    The amendment is intended to reach violations of applicable 
professional standards that demonstrate that an accountant lacks 
competence to practice before the Commission. An accountant who acts 
intentionally or knowingly, including recklessly, or highly 
unreasonably when heightened scrutiny is warranted, conclusively 
demonstrates a lack of competence to practice before the Commission. By 
contrast, when the Commission brings a Rule 102(e) proceeding for 
repeated instances of unreasonable conduct, it will also have to find 
that the conduct indicates a lack of competence.
    The Commission received 168 comment letters on the proposed 
amendment to Rule 102(e). A number of commenters, including individual 
investors, institutional investors, public interest groups, officers 
and directors of public companies, and academics, supported the 
proposed amendment. Several certified public accountants (``CPAs'') 
also expressed their support for the proposed amendment. Most other 
commenters supported at least some aspects of the proposed amendment. A 
substantial number of CPAs submitted letters that expressed agreement 
with an August 1998 memorandum of the American Institute of Certified 
Public Accountants (``AICPA'') criticizing certain aspects of the 
proposed amendment. Most of these CPA commenters also expressed their 
support for the amendment to Rule 102(e) proposed in the AICPA's May 7, 
1998 rulemaking petition.\7\ In addition, the five largest U.S. 
accounting firms and members of interested committees of the American 
Bar Association submitted letters supporting some, but critical of 
other, aspects of the proposed amendment.
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    \7\ On May 7, 1998, the AICPA submitted a rulemaking petition to 
the Commission proposing a definition for ``improper professional 
conduct'' under Rule 102(e)(1)(ii). Rulemaking Petition by the AICPA 
Concerning Rule 102(e) (``AICPA Rulemaking Petition''), SEC File No. 
4-410 (May 7, 1998).
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    The Commission acted as expeditiously as practicable in adopting 
this amendment. The Commission wants to address promptly the Checkosky 
II court's concern that the Commission had not clearly articulated its 
standard for determining when accountants engage in ``improper 
professional conduct.'' Equally important, the Commission wants to make 
sure that its processes continue to be protected, and that the 
investing public continues to have confidence in the integrity of the 
financial reporting process.
    Accurate financial reporting is the bedrock of our capital markets. 
Accountants play a vital role in assuring issuers' compliance with 
reporting requirements. The Commission wishes

[[Page 57165]]

to underscore the importance of that role and the need for accountants 
to comply with the standards of conduct applicable to members of their 
profession. These professional standards include the overarching 
requirement that auditors exercise due care in their audit of a 
company's financial statements. The Commission possesses broad 
authority, both under the federal securities laws and its own rules, to 
promote and enforce compliance with professional standards.
    Rule 102(e) addresses that category of professional conduct that 
threatens harm to the Commission's processes. The rule was not intended 
to cover all forms of professional misconduct. As discussed below,\8\ 
the Commission has separate statutory authority that is available to 
address and deter professional misconduct that is not encompassed by 
Rule 102(e), as amended in this release.
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    \8\ See discussion on p.20.
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    The final rule amendment clarifies the Commission's standard for 
determining when ``improper professional conduct'' occurs under Rule 
102(e)(1)(ii). The amendment will allow the Commission to bring the 
actions it traditionally has brought under Rule 102(e)(1)(ii). 
Moreover, the purpose served and the relief provided by the rule are 
forward-looking. For these reasons, the Commission will use this 
standard in all cases considered after the amendment's effective date, 
except where a trial before an Administrative Law Judge has already 
commenced,\9\ regardless of when the conduct in question occurred.
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    \9\ Where a hearing has already commenced, an Administrative Law 
Judge may use the Rule 102(e) standard adopted today if such use 
would not unfairly prejudice any party. The Administrative Law Judge 
may also supplement or re-open the record, if necessary, to give any 
party so requesting the opportunity to provide particular evidence 
or briefing on the Rule 102(e) standard.
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II. Background

A. The Importance of Rule 102(e)

    Under Rule 102(e), the Commission can censure, suspend or bar 
professionals who appear or practice before it. Specifically, pursuant 
to the rule, the Commission can impose a sanction upon a professional 
whom it finds, after notice and an opportunity for hearing:

    (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.\10\

    \10\ 17 CFR 201.102(e)(1)(i), (ii) and (iii).
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    The Commission adopted Rule 102(e) as a ``means to ensure that 
those professionals, on whom the Commission relies heavily in the 
performance of its statutory duties, perform their tasks diligently and 
with a reasonable degree of competence.'' \11\ Courts have recognized 
that it is appropriate for the Commission to use a remedial rule such 
as Rule 102(e) to encourage professionals to adhere to professional 
standards and minimum standards of competence when they practice before 
the Commission. In adopting the rule, the Commission did not intend to 
add an ``additional weapon'' to its ``enforcement arsenal,'' \12\ but 
to protect the integrity and quality of its system of securities 
regulation and, by extension, the interests of the investing public.
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    \11\ Touche Ross & Co. v. SEC, 609 F.2d 570, 582 (2d Cir. 1979).
    \12\ Id. at 579.
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B. The Important Role of Accountants

    Accountants play many roles in the Commission's system of 
securities regulation. One of the most significant roles is in auditing 
financial statements filed with the Commission. This release focuses 
particular attention upon the role of auditors in the securities 
registration and reporting processes under the federal securities laws. 
The amendment, however, covers all accountants who appear or practice 
before the Commission.\13\
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    \13\ See 17 CFR 201.102(f)(1) and (2). For example, the 
Commission has brought Rule 102(e) proceedings against accountants 
serving as officers of public companies. See, e.g., In re Terrano, 
Securities Exchange Act of 1934 (``Exchange Act'') Release No. 39485 
(Dec. 23, 1997), 66 SEC Docket 494 (Jan. 20, 1998); In re Hersh, 
Exchange Act Release No. 39089 (Sept. 18, 1997), 65 SEC Docket 1170 
(Oct. 14, 1997); In re Bryan, Exchange Act Release No. 39077 (Sept. 
15, 1997), 65 SEC Docket 1129 (Oct. 14, 1997).
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    ``Corporate financial statements are one of the primary sources of 
information available to guide the decisions of the investing 
public.''\14\ Various provisions of the federal securities laws require 
publicly-held companies to file audited financial statements with the 
Commission.\15\ These financial statements must be audited by 
independent accountants in accordance with generally accepted auditing 
standards (``GAAS'').\16\ The auditor plans and performs the audit to 
obtain reasonable assurance that the financial statements are free from 
material misstatement. Commission regulations require the auditor to 
issue a report containing an opinion on the financial statements.\17\ 
The auditor's opinion states whether the audit was conducted in 
accordance with GAAS, and whether the financial statements present 
fairly, in all material respects, the financial position of the company 
as of a specific date and the results of its operations and its cash 
flows for the year (or other period) then ended, in conformity with 
generally accepted accounting principles (``GAAP'').\18\
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    \14\ U.S. v. Arthur Young & Co., 465 U.S. 805, 810 (1984).
    \15\ See, e.g., Securities Act of 1933 (``Securities Act'') 
Schedule A (25)-(27), 15 U.S.C. 77aa(25)-(27); Exchange Act 
12(b)(1)(J)-(L), 15 U.S.C. 78l(b)(1)(J)-(L).
    \16\ Regulation S-X, 17 CFR 210.1-02(d) (1997).
    \17\ See Regulation S-X, 17 CFR 210.2-02 (1997).
    \18\ Id. 
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    Investors have come to rely on the accuracy of the financial 
statements of public companies when making investment decisions. 
Because the Commission has limited resources, it cannot closely 
scrutinize every financial statement.\19\ Consequently, the Commission 
must rely on the competence and independence of the auditors who 
certify, and the accountants who prepare, financial statements. In 
short, both the Commission and the investing public rely heavily on 
accountants to assure corporate compliance with federal securities law 
requirements and disclosure of accurate and reliable financial 
information.
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    \19\ See Touche Ross, 609 F.2d at 580-81.
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    The Commission and the courts have long acknowledged ``[t]he duty 
of accountants to those who justifiably rely on [their] reports.'' \20\ 
The AICPA's Code of Professional Conduct contains the strong statement 
that ``[t]hose who rely on certified public accountants expect them to 
discharge their responsibilities with integrity, objectivity, due 
professional care, and a genuine interest in serving the public.'' \21\ 
Due care requires auditors to discharge their responsibilities with 
competence and diligence and consistent with the profession's 
responsibility to the public. Moreover, GAAS requires that ``due 
professional care'' be exercised in the performance of audits.\22\ 
Accountants who issue audit and other reports speak to investors, 
publicly representing that the accounting and auditing standards of the 
accounting profession have been followed.\23\ An incompetent accountant 
can damage the Commission's processes

[[Page 57166]]

and erode investor confidence in our markets.\24\
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    \20\ In re Carter, Exchange Act Release No. 17595 (Feb. 28, 
1981), 22 SEC Docket 292, 298 (Mar. 17, 1981). Cf. Arthur Young, 465 
U.S. at 817-18.
    \21\ AICPA Professional Standards, Vol. 2 ET section 53.03 
(1997).
    \22\ AICPA Professional Standards, Vol. 1 AU section 230.01 
(1997).
    \23\ See Carter, 22 SEC Docket at 298.
    \24\ ``In our complex society the accountant's certificate * * * 
can be instruments for inflicting pecuniary loss more potent than 
the chisel or the crowbar.'' U.S. v. Benjamin, 328 F.2d 854, 863 (2d 
Cir.), cert. denied, 377 U.S. 953 (1964).
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C. The ``Improper Professional Conduct'' Standard Applied to 
Accountants

    The Court of Appeals in Checkosky II criticized the Commission for 
not clearly articulating in that case when an accountant would be 
deemed to have engaged in ``improper professional conduct'' under Rule 
102(e)(1)(ii). The amendment adopted today addresses this concern by 
specifying three types of conduct that constitute ``improper 
professional conduct.'' The Commission believes that a finding of 
``improper professional conduct'' under Rule 102(e) is warranted only 
when an accountant lacks competence \25\ to practice before the 
Commission.
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    \25\ By ``competence'' the Commission means not just technical 
skills, but also an accountant's willingness and ability to adhere 
to professional standards, including standards of honesty and fair 
dealing.
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    Rule 102(e)(1)(ii) has been an effective remedial tool because it 
covers a range of conduct that demonstrates that a professional is a 
future threat to the Commission's processes.\26\ Accountants who engage 
in intentional or knowing conduct, which includes reckless conduct, 
clearly pose this type of future threat. Accountants who engage in 
certain specified types of negligent conduct also can pose such a 
future threat.
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    \26\ Carter, 22 SEC Docket at 297. Because the purpose of Rule 
102(e)(1)(ii) is to address conduct that demonstrates a future 
threat to the Commission's processes, the rule is remedial and not 
punitive in nature.
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    Rule 102(e)(1)(ii) is not meant, however, to encompass every 
professional misstep.\27\ A single judgment error, for example, even if 
unreasonable when made, may not indicate a lack of competence to 
practice before the Commission and, therefore, may not pose a future 
threat to the Commission's processes sufficient to require Commission 
action under Rule 102(e)(1)(ii).\28\
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    \27\ As Commissioner Johnson has noted:
    A professional often must make difficult decisions, navigating 
through complex statutory and regulatory requirements, and in the 
case of accountants, complying with [GAAS] and applying [GAAP]. 
These determinations require the application of independent 
professional judgment and sometimes involve matters of first 
impression.
    In re Checkosky, Exchange Act Release No. 38183 (Jan. 21, 1997), 
63 SEC Docket 1948, 1976 (Feb. 18, 1997) (Johnson, Comm'r, 
dissenting), rev'd Checkosky II.
    \28\ Such an error, however, may violate applicable professional 
standards. For example, the AICPA's Code of Professional Conduct and 
GAAS require accountants to exercise due care. In addition, such an 
error may result in a violation of the federal securities laws. See 
discussion at p. 20. In either event, the person committing such an 
error, though not subject to discipline under Rule 102(e), would be 
exposed to the sanctions available under those other provisions.
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    The Commission believes that a single judgment error that was 
highly unreasonable and made in circumstances warranting heightened 
scrutiny, however, conclusively demonstrates a lack of competence to 
practice before the Commission.\29\ Repeated judgment errors may also 
indicate a lack of competence. Therefore, if the Commission finds that 
an accountant acted unreasonably in more than one instance (each time 
resulting in a violation of applicable professional standards), and 
that this conduct indicates a lack of competence, that accountant 
engaged in improper professional conduct under the standard adopted 
today.\30\
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    \29\ See Section III.C.1 below.
    \30\ See Section III.C.2 below.
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    The Commission does not seek to use Rule 102(e)(1)(ii) to establish 
new standards for the accounting profession. The rule itself imposes no 
new professional standards on accountants. Accountants who appear or 
practice before the Commission are already subject to professional 
standards. Indeed, the Commission will only bring Rule 102(e)(1)(ii) 
proceedings against accountants who violate applicable professional 
standards in circumstances that demonstrate their lack of competence to 
practice before the Commission.\31\
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    \31\ Under Rule 102(e), the Commission has other authority to 
protect the integrity of its processes from persons who pose a 
threat of future harm to those processes. For example, the 
Commission may censure, suspend or bar persons who the Commission 
finds ``not to possess the requisite qualifications to represent 
others.'' 17 CFR 201.102(e)(1)(i).
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III. Discussion of Amendment

A. The Final Rule

    The amendment specifies three types of conduct that constitute 
``improper professional conduct'' under Rule 102(e)(1)(ii). The 
amendment states:

    (iv) With respect to persons licensed to practice as 
accountants, ``improper professional conduct'' under 
Sec. 201.102(e)(1)(ii) means:
    (A) Intentional or knowing conduct, including reckless conduct, 
that results in a violation of applicable professional standards; or
    (B) Either of the following two types of negligent conduct:
    (1) A single instance of highly unreasonable conduct that 
results in a violation of applicable professional standards in 
circumstances in which an accountant knows, or should know, that 
heightened scrutiny is warranted.
    (2) Repeated instances of unreasonable conduct, each resulting 
in a violation of applicable professional standards, that indicate a 
lack of competence to practice before the Commission.

    Each section of the final rule amendment refers to a violation of 
``applicable professional standards.'' \32\ The term ``applicable 
professional standards'' primarily refers to GAAP, GAAS, the AICPA Code 
of Professional Conduct, and Commission regulations. Also included are 
generally accepted standards routinely used by accountants in the 
preparation of statements, opinions, or other papers filed with the 
Commission.
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    \32\ The final rule amendment will not change the Commission's 
practice of bringing Rule 102(e) proceedings against accountants who 
lack independence. See, e.g., In re Goodbread, Exch. Act Rel. No. 
38035 (Dec. 12, 1996), SEC Accounting Rules [Current Binder] (CCH) 
para. 5,061 (Mar. 1997); In re Iommazzo, Exch. Act Rel. No. 30733 
(May 22, 1992), Accounting Series Releases, [1991-95 Transfer 
Binder] Fed. Sec. L. Rep. (CCH) para. 73,844 (July 19, 1995).
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    The term ``applicable professional standards'' is broad enough to 
accommodate changes in the body of professional guidance routinely used 
by accountants. For example, should international accounting standards 
be adopted, they would become part of accepted professional guidance. 
Likewise, pronouncements of the Independence Standards Board, or other 
bodies yet to be established, would come to form part of the 
professional guidance that accountants routinely use. As the AICPA 
concluded, the term ``applicable professional standards'' is one ``that 
professionals are generally familiar with and can understand.'' \33\
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    \33\ Comment Letter of Richard I. Miller, General Counsel & 
Secretary, AICPA, at 9 (Aug. 20, 1998) (``AICPA Comment Letter'').
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B. Intentional or Knowing Conduct, Including Reckless Conduct

    Subparagraph (A) of the amendment defines ``improper professional 
conduct'' to include the most blatant violations of applicable 
professional standards. The Commission consistently has used Rule 
102(e) proceedings to address these types of violations of applicable 
professional standards.\34\
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    \34\ See, e.g., In re Finkel, Securities Act Release No. 7401 
(Mar. 12, 1997), 64 SEC Docket 103 (Apr. 8, 1997); In re Basson, 
Exchange Act Release No. 35840 (June 13, 1995), 59 SEC Docket 1650 
(July 11, 1995); In re F.G. Masquelette & Co., Accounting Series 
Release No. 68, [1937-1982 Transfer Binder] Fed. Sec. L. Rep. (CCH), 
para. 72,087 (June 30, 1982); In re Weiner, Exchange Act Rel. No. 
14249 (Dec. 12, 1977), 13 SEC Docket 1113 (Dec. 27, 1977).
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    The Commission is adopting subparagraph (A) of the amendment in

[[Page 57167]]

substantially the same form as it was proposed. Almost all commenters 
expressed support for subparagraph (A) of the proposed amendment. 
Clearly, an accountant who intentionally or knowingly, including 
recklessly, violates the professional standards conclusively 
demonstrates a lack of competence to appear before the Commission. 
Accountants who engage in this type of misconduct pose a future threat 
to the Commission's processes.
    The Commission also requested comments on what definition of 
``recklessness'' is most appropriate. Several commenters suggested that 
the Commission adopt a definition of ``recklessness'' used in cases 
brought under Section 10(b) and Rule 10b-5 of the Securities Exchange 
Act.\35\ Although the standards of professional practice are not fraud 
based, the Commission agrees that, for purposes of consistency under 
the federal securities laws, ``recklessness'' in subparagraph (A) of 
the rule amendment should mean the same thing as courts have defined 
``recklessness'' to mean under the antifraud provisions. 
``Recklessness'' under the antifraud provisions ``is not merely a 
heightened 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 [actor] or is 
so obvious that the actor must have been aware of it.' '' \36\ This 
recklessness standard is a lesser form of intent.\37\
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    \35\ See, e.g., Comment Letter of Ernst & Young LLP, at 19-20 
(Aug. 20, 1998) (``Ernst & Young Comment Letter''); AICPA Comment 
Letter, at 8.
    \36\ SEC v. Steadman, 967 F.2d 636, 641 (D.C. Cir. 1992) 
(ellipsis in original) (quoting Sundstrand Corp. v. Sun Chemical 
Corp., 553 F.2d 1033, 1045 (7th Cir.), cert. denied, 434 U.S. 875 
(1977)); see also Potts v. SEC, 151 F.3d 810 (8th Cir. 1998) 
(finding recklessness under the Steadman standard in a Rule 102(e) 
proceeding).
    \37\ See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193-94 n.12 
(1976); see also Steadman, 967 F.2d at 641.
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C. Two Specific Types of Negligent Conduct

    The final rule amendment also covers two specific types of 
negligent conduct that result in violations of applicable professional 
standards.\38\ The Commission believes that a negligent auditor can do 
just as much harm to the Commission's processes as one who acts with an 
improper motive.\39\ For this reason, the Commission has brought Rule 
102(e) proceedings based on negligent conduct.\40\
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    \38\ In other instances, the federal securities laws expressly 
subject auditors to liability without requiring intentional 
misconduct. For example, the Supreme Court has recognized that 
section 11 allows recovery for ``negligent conduct.'' Herman & 
MacLean v. Huddleston, 459 U.S. 375, 384 (1983), referring to Ernst 
& Ernst v. Hochfelder, 425 U.S. 185, 210 (1976). See also Securities 
Act section 17(a) (2) & (3), 15 U.S.C. 77q(a)(2) & (3); Aaron v. 
SEC, 446 U.S. 680 (1980). In addition, section 21C of the Exchange 
Act imposes liability when a person is a ``cause'' of a violation 
``due to an act or omission the person knew or should have known 
would contribute to such violation.'' 15 U.S.C. 78u-3.
    \39\ The AICPA Rulemaking Petition would define improper 
professional conduct in a manner that includes a knowing violation 
and a conscious and deliberate disregard of the professional 
standards, as well as a course or pattern of misconduct. The 
amendment adopted today by the Commission, similar to the AICPA 
Rulemaking Petition, subjects accountants who engage in knowing 
misconduct as well as a course or pattern of misconduct to Rule 
102(e)(1)(ii) proceedings. The amendment adopted today includes two 
specific types of negligent conduct. The Commission believes that 
the public interest will be better served by its broader definition 
of ``improper professional conduct.''
    \40\ See, e.g., In re Gotthilf, Exchange Act Release No. 33949 
(April 21, 1994), 56 SEC Docket 1543 (May 10, 1994). See also Danna 
v. SEC, No. C-93-4158 (CW), 1994 WL 315877 (N.D. Cal. Feb. 8, 1994).
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    The Court of Appeals in Checkosky II faulted the Commission for not 
articulating with specificity when negligent conduct by an accountant 
constitutes ``improper professional conduct.'' \41\ The final rule 
amendment provides this specificity. Subparagraph (B) of the amendment 
defines ``improper professional conduct'' to include two specific types 
of negligent conduct:

    \41\ Checkosky II, 139 F.3d at 224.
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    (1) A single instance of highly unreasonable conduct that 
results in a violation of applicable professional standards in 
circumstances in which an accountant knows, or should know, that 
heightened scrutiny is warranted.
    (2) Repeated instances of unreasonable conduct, each resulting 
in a violation of applicable professional standards, that indicate a 
lack of competence to practice before the Commission.
1. Highly Unreasonable Conduct
    The ``highly unreasonable'' standard in subparagraph (B)(1) of the 
final rule amendment is an intermediate standard, higher than ordinary 
negligence but lower than the traditional definition of recklessness 
used in cases brought under Section 10(b) and Rule 10b-5 of the 
Exchange Act.\42\ The ``highly unreasonable'' standard is an objective 
standard. The conduct at issue is measured by the degree of the 
departure from professional standards and not the intent of the 
accountant. The Commission believes that subparagraph (B)(1) describes 
conduct that poses a threat of future harm to the Commission's 
processes and conclusively demonstrates that the accountant lacks 
competence to practice before it.
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    \42\ The Commission notes that several cases interpreting the 
antifraud provisions of the federal securities laws use the phrase 
``highly unreasonable'' as part of the definition of recklessness. 
See, e.g., Sundstrand, 553 F.2d at 1045. The Commission does not 
mean to incorporate that case law by using the term ``highly 
unreasonable'' in this context. This release defines the ``highly 
unreasonable'' standard--an intermediate standard higher than 
ordinary negligence and lower than recklessness--with care and 
precision. The ``highly unreasonable'' standard adopted today is not 
scienter-based.
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    The proposed rule referred to ``unreasonable'' conduct.\43\ The 
definition the Commission adopts today includes a higher standard. The 
final standard reflects the Commission's conclusion that a single 
judgment error, even if unreasonable when made, may not indicate a lack 
of competence to practice before the Commission and, therefore may not 
pose a future threat to the Commission's processes sufficient to impose 
remedial sanctions. The Commission neither accepts nor condones 
unreasonable, or negligent, accounting or auditing errors. To the 
contrary, such errors could undermine accurate financial reporting. 
Moreover, the Commission possesses authority, wholly independent of 
Rule 102(e), to address and deter such errors through its enforcement 
of provisions of the federal securities laws that impose liability on 
persons, including accountants, for negligent conduct.\44\
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    \43\ In fact, the proposed rule referred to ``[a]n unreasonable 
violation.'' At least one commenter correctly pointed out that this 
formulation implies there may be ``reasonable'' violations of 
professional standards. Comment Letter of K. Michael Conaway (Aug. 
20, 1998). To eliminate this misconception, and to focus on 
individual competence, the final rule refers to ``unreasonable 
conduct,'' not ``violations.''
    \44\ See, e.g., Securities Act section 17(a)(2) & (3), 15 U.S.C. 
77q(a)(2) & (3); Exchange Act section 21C, 15 U.S.C. 78u-3; see also 
Securities Act section 11, 15 U.S.C. 77k. Accountants also may be 
liable for negligent conduct under the laws of various states, and 
subject to sanction by state accounting boards, see, e.g., Fla. 
Admin. Code Ann. r. 61H1-36.004 (1998).
---------------------------------------------------------------------------

    Many commenters objected to the ``unreasonable'' formulation in 
this subparagraph of the proposed rule or suggested changes to this 
subparagraph. Some CPAs and other commenters, for example, expressed 
concern that the ``unreasonable'' formulation made accountants unfairly 
vulnerable and liable for acts of ``simple negligence'' and errors in 
judgment.\45\ These commenters maintained that such a standard could 
restrict accountants' exercise of their best independent judgment, 
thereby operating to the

[[Page 57168]]

detriment of the financial reporting system.\46\
---------------------------------------------------------------------------

    \45\ AICPA Comment Letter, at 15-16; Comment Letter of Arthur 
Andersen LLP, at 5 (Aug. 17, 1998) (``Arthur Andersen Comment 
Letter''); Comment Letter of Robert K. Elliott, Partner, KPMG Peat 
Marwick LLP, at 10-12 (Aug. 20, 1998) (``KPMG Peat Marwick Comment 
Letter).
    \46\ Most investors and users of financial statements, however, 
disagreed. See Comment Letter of Peter C. Clapman, Senior Vice 
President and Chief Counsel, Investments, TIAA-CREF, at 4 (July 16, 
1998); Comment Letter of Josh S. Weston, Chairman of the Board, 
Automatic Data Processing, Inc. (Aug. 24, 1998) (``Weston Comment 
Letter''); Comment Letter of Dr. John H. Nugent (Aug. 11, 1998) 
(``Nugent Comment Letter''); Comment Letter of Kurt N. Schacht, 
Chief Legal Officer, State of Wisconsin Investment Board, at 1 (July 
20, 1998); Comment Letter of Laurence A. Tisch, Co-Chairman of the 
Board and Co-Chief Executive Officer, Loews Corporation (July 8, 
1998); Comment Letter of Steven Alan Bennett, Senior Vice President 
and General Counsel, Banc One Corporation, at 2 (July 21, 1998). 
Moreover, commenters from one state board of accountancy supported 
the proposed standard. Comment Letter of Martha P. Willis, Division 
Director, State of Florida, Department of Business and Professional 
Regulation (Aug. 21, 1998).
---------------------------------------------------------------------------

    Creating an undue fear that an isolated error in judgment would 
result in a 102(e) proceeding could be counterproductive in some 
limited instances.\47\ These concerns are eliminated as to Rule 102(e), 
or at least alleviated, by raising the threshold for improper 
professional conduct from one instance of ``unreasonable'' conduct to 
one instance of ``highly unreasonable'' conduct. Subparagraph (B)(1) of 
the final rule amendment does not permit the Commission to evaluate 
actions or judgments in the stark light of hindsight, but focuses 
instead on what an accountant knew, or should have known, at the time 
an action was taken or a decision was made. Indeed, three of the five 
largest accounting firms--who expressed concern that the 
``unreasonable'' formulation would chill accountants'' use of their 
best judgment--suggested that the Commission could appropriately adopt 
a ``highly unreasonable'' formulation.\48\ And, as one commenter 
pointed out, most state licensing provisions include a ``gross 
negligence'' standard.\49\
---------------------------------------------------------------------------

    \47\ However, such an error could have legal consequences. See 
discussion on p. 20.
    \48\ Comment Letter of J. Michael Cook, Chairman and Chief 
Executive Officer, and Phillip R. Rotner, General Counsel, Deloitte 
& Touche LLP, at 6 (``Deloitte & Touche Comment Letter''); Ernst & 
Young Comment Letter, at 24; Comment Letter of 
PricewaterhouseCoopers, at 7 (Aug. 20, 1998) 
(``PricewaterhouseCoopers Comment Letter'').
    \49\ Comment Letter of Wayne A. Kolins, National Director of 
Accounting and Auditing, BDO Seidman LLP, at 9 (Aug. 19, 1998) 
(citing Uniform Accounting Act section 10(5)). The Commission is not 
adopting a ``gross negligence'' standard because courts have not 
interpreted the term uniformly. The Commission does not want to 
adopt a standard that has already been subject to varying 
interpretations. Fairness to accountants and sound public policy is 
furthered by using new terminology--the ``highly unreasonable'' 
standard--which is defined in this release with precision and 
clarity. However, the term ``gross negligence'' is often used--like 
the Commission's use of the phrase ``highly unreasonable''--as an 
intermediate standard between ordinary negligence and recklessness.
---------------------------------------------------------------------------

    Some commenters questioned whether raising the standard above 
ordinary negligence was consistent with the purpose of Rule 
102(e)(1)(ii) to protect the integrity of the Commission's 
processes.\50\ These commenters strongly argued that a negligence 
standard is needed because accurate financial statements are essential 
to the investment decision-making process and auditors play a critical 
role in maintaining investor confidence in the reliability of financial 
statements.\51\ The heightened standard of ``highly unreasonable'' 
strikes the appropriate balance between the Commission's need to 
protect its processes and accountants' ability to exercise judgment. In 
the Commission's view, the balance is appropriate in part because of 
the availability of remedies other than Rule 102(e) to address ordinary 
negligence. The final rule amendment, therefore, is fully consistent 
with the remedial purposes of Rule 102(e).
---------------------------------------------------------------------------

    \50\ Weston Comment Letter; Comment Letter of William B. 
Patterson, Director, Office of Investments, AFL-CIO, at 2 (Aug. 10, 
1998) (``AFL-CIO Comment Letter''); see also Comment Letter of 
Patricia D. McQueen, Vice President, Advocacy, Financial Reporting & 
Disclosure, and Jonathan J. Stokes, Vice President, Professional 
Conduct Program, Association for Investment Management and Research, 
at 3 (Aug. 18, 1998).
    \51\ See Weston Comment Letter; AFL-CIO Comment Letter, at 2; 
Nugent Comment Letter; BancOne Comment Letter, at 2; TIAA-CREF 
Comment Letter, at 3.
---------------------------------------------------------------------------

    The final rule amendment provides that the Commission will bring 
cases under subparagraph (B)(1) only when an accountant knows or should 
know that heightened scrutiny is appropriate. The ``heightened 
scrutiny'' provision is also an objective standard. Again, the 
touchstone is the reasonable accountant. ``Heightened scrutiny'' would 
be warranted when matters are important or material, or when warning 
signals or other factors should alert an accountant of a heightened 
risk,\52\ or as set forth in applicable professional standards.\53\ 
Because of the importance of an accountant's independence to the 
integrity of the financial reporting system, the Commission has 
concluded that circumstances that raise questions about an accountant's 
independence always merit heightened scrutiny. Therefore, if an 
accountant acts highly unreasonably with respect to an independence 
issue, that accountant has engaged in ``improper professional 
conduct.''
---------------------------------------------------------------------------

    \52\See, e.g., In re Hope, Accounting and Auditing Enforcement 
Release No. 109A (Aug. 6, 1986), 36 SEC Docket 663, 750-55 (Sept. 
10, 1986).
    \53\ Cf. AICPA Professional Standards, Vol. 1 AU sections 312 
and 316 (1997).
---------------------------------------------------------------------------

    The proposed amendment focused on conduct presenting ``a 
substantial risk, which is either known or should have been known,'' of 
making a document filed with the Commission ``materially misleading.'' 
At least one commenter questioned whether the phrase was overbroad.\54\ 
Other commenters correctly noted that the Commission's standard should 
not depend on the impact of a violation on financial statements filed 
with the Commission.\55\ The proper focus should be on the conduct 
itself, rather than on the risk of harm posed by the conduct.\56\
---------------------------------------------------------------------------

    \54\ PricewaterhouseCoopers Comment Letter, at 5. See also AICPA 
Comment Letter, at 17.
    \55\ Comment Letter of John M. Liftin, Chair, Committee on 
Federal Regulation of Securities, and Richard H. Rowe, Chair, 
Committee on Law and Accounting, ABA Section of Business Law, at 12 
(Aug. 19, 1998).
    \56\ See Comment Letter of William T. Allen, at 3 (July 10, 
1998) (``Allen Comment Letter'') (suggesting this approach).
---------------------------------------------------------------------------

    This change from the proposed rule amendment is consistent with the 
purpose of Rule 102(e)(1)(ii) to protect the Commission's processes 
from accountants who lack competence to appear before it. The final 
rule amendment addresses this issue by focusing on the behavior of an 
accountant under the facts and circumstances presented at the time. The 
standard does not permit judgment by hindsight, but rather compares the 
actions taken by an accountant at the time of the violation with the 
actions a reasonable accountant should have taken if faced with the 
same situation.
    One commenter stated that filing a materially false or misleading 
document with the Commission should be a ``threshold requirement'' for 
a finding of improper professional conduct.\57\ The Commission 
disagrees. The Commission does not need to show that the accountant's 
behavior actually caused harm; an accountant can demonstrate a lack of 
competence even if his conduct did not result in the filing of a false 
or misleading document. An auditor who fails to audit properly under 
GAAS--whether recklessly or highly unreasonably--should not be shielded 
because the audited financial statements fortuitously turn out to be 
accurate or not materially misleading. For example, the financial 
statements of a large company's subsidiary that have been audited by an 
accountant who acted recklessly or highly unreasonably in violation of 
GAAS may not be material to the consolidated financial statements filed 
by the company with the Commission. In that situation, the

[[Page 57169]]

accountant has demonstrated a lack of competence.
---------------------------------------------------------------------------

    \57\ PricewaterhouseCoopers Comment Letter, at 5.
---------------------------------------------------------------------------

    Some commenters contended that the Commission should not have 
special rules for accountants. These commenters claimed further that, 
when compared to the standard applied to lawyers, the proposed rule 
``discriminates'' against accountants.\58\ As explained earlier, the 
amendment to Rule 102(e) focuses on accountants in response to the 
Checkosky II decision and the need to assure the protection of the 
Commission's financial reporting process. As noted, this release does 
not address the conduct of lawyers.
---------------------------------------------------------------------------

    \58\ See, e.g., AICPA Comment Letter, at 21-23; Ernst & Young 
Comment Letter, at 18-19; KPMG Peat Marwick Comment Letter, at 6-8; 
Arthur Andersen Comment Letter, at 7-8.
---------------------------------------------------------------------------

2. Repeated Instances of Unreasonable Conduct
    Subparagraph B(2) of the final rule amendment addresses 
``[r]epeated instances of unreasonable conduct, each resulting in a 
violation of applicable professional standards.'' Repeated instances of 
unreasonable conduct by an accountant, each resulting in a violation of 
applicable professional standards, can damage both the Commission's 
processes and investor confidence in the integrity of financial 
statements. Most commenters who addressed the issue supported the 
notion of bringing Rule 102(e) proceedings against accountants who 
engage in repeated instances of negligent conduct.\59\
---------------------------------------------------------------------------

    \59\ See, e.g., Allen Comment Letter, at 1.
---------------------------------------------------------------------------

    The term ``unreasonable,'' as distinguished from the term ``highly 
unreasonable'' used in subparagraph B(1), connotes an ordinary or 
simple negligence standard. The lower standard of culpability is 
justified in this instance because the repetition of the unreasonable 
conduct may show the accountant's lack of competence to practice before 
the Commission. If an accountant fails to exercise reasonable care on 
more than one occasion, the Commission's processes may be threatened. 
More than one violation of applicable professional standards ordinarily 
will indicate a lack of competence.
    A few commenters raised questions about what would constitute 
``repeated instances'' of unreasonable conduct.\60\ ``Repeated 
instances'' means more than once. The term ``repeated'' may encompass 
as few as two separate instances of unreasonable conduct occurring 
within one audit, or separate instances of unreasonable conduct within 
different audits. For example, if an auditor fails to gather evidential 
matter for more than two accounts, or certifies accounting inconsistent 
with GAAP in more than two accounts, that conduct constitutes 
``repeated instances'' of unreasonable conduct. By contrast, a single 
error that results in an issuer's financial statements being misstated 
in more than one place would not, by itself, constitute a violation of 
this subparagraph. Certification of accounting inconsistent with GAAP 
in two or more situations, however, may indicate an accountant's basic 
unfamiliarity with the standards of the profession, which may 
constitute improper professional conduct under subparagraph B(2).
---------------------------------------------------------------------------

    \60\ Ernst & Young Comment Letter, at 21-22 (suggesting that the 
term ``repeated'' include more than two violations); KPMG Peat 
Marwick Comment Letter, at 13; see also Comment Letter of Terry 
Warfield, PricewaterhouseCoopers Research Scholar, Associate 
Professor, University of Wisconsin (Aug. 1, 1998).
---------------------------------------------------------------------------

    The Commission recognizes that ``repeated instances'' may not 
always demonstrate a lack of competence to practice before the 
Commission. Although the Commission believes that more than one 
instance of unreasonable conduct will ordinarily indicate a lack of 
competence, unlike subparagraphs (A) and (B)(1), this subparagraph 
requires the Commission to make a specific finding that the conduct 
indicates a lack of competence. The finding is based on an evaluation 
of the conduct itself and does not require a separate evidentiary 
basis. This finding is required because two isolated violations of 
applicable professional standards, for example GAAS, may not pose a 
threat to the Commission's processes.

D. Authority

    Some commenters questioned the Commission's authority to adopt a 
negligence standard under Rule 102(e). As stated in the Proposing 
Release, Rule 102(e) was promulgated under the Commission's broad 
authority to adopt those rules and regulations necessary for carrying 
out its designated functions,\61\ and its inherent authority to protect 
the integrity of its processes. As the Supreme Court has held, ``the 
validity of a regulation promulgated [under an agency's general 
rulemaking authority] will be sustained so long as it is `reasonably 
related to the purposes of the enabling legislation.' '' \62\
---------------------------------------------------------------------------

    \61\ See Securities Act section 19(a), 15 U.S.C. 77s(a), 
Securities Exchange Act section 23(a), 15 U.S.C. 78w(a), Public 
Utility Holding Company Act of 1935 section 20(a), 15 U.S.C. 79t(a), 
Trust Indenture Act of 1939 section 319(a), 15 U.S.C. 77sss(a), 
Investment Advisers Act of 1940 section 211(a), 15 U.S.C. 80b-11(a), 
and Investment Company Act section 38(a), 15 U.S.C. 80a-37(a).
    \62\ Mourning v. Family Publication Services, Inc., 411 U.S. 
356, 369 (1973) (quoting Thorpe v. Housing Authority of the City of 
Durham, 393 U.S. 268, 280-81 (1969)).
---------------------------------------------------------------------------

    Three U.S. Courts of Appeals have upheld the validity of Rule 
102(e).\63\ As the U.S. Court of Appeals for the Second Circuit 
recognized:
---------------------------------------------------------------------------

    \63\ See Touche Ross, 609 F.2d at 582; Sheldon v. SEC, 45 F.3d 
1515, 1518 (11th Cir. 1995); Davy v. SEC, 792 F.2d 1418, 1421 (9th 
Cir. 1986); see also Potts, 151 F.3d 810.

    [Rule 102(e)] represents an attempt by the Commission to protect 
the integrity of its own processes. It provides the Commission with 
the means to ensure that those professionals, on whom the Commission 
relies heavily in the performance of its statutory duties, perform 
their tasks diligently and with a reasonable degree of competence. 
As such the Rule is 'reasonably related' to the purposes of the 
securities laws.\64\
---------------------------------------------------------------------------

    \64\ Touche Ross, 609 F.2d at 582 (quoting Mourning, 411 U.S. at 
369).

One district court has explicitly held that the Commission's Rule 
102(e) authority is not limited to instances of intentional misconduct 
or bad faith.\65\
---------------------------------------------------------------------------

    \65\ See Danna v. SEC, No. C-93-4158 (CW), 1994 WL 315877 (N.D. 
Cal. Feb. 8, 1994).
---------------------------------------------------------------------------

    Some commenters either referred to, or echoed, concerns expressed 
in the separate opinions of two judges of the U.S. Court of Appeals for 
the D.C. Circuit in Checkosky I questioning the Commission's authority 
to use a negligence standard for ``improper professional conduct'' 
under Rule 102(e).\66\ One judge suggested that, if the Commission were 
to determine that an accountant's negligence was a per se violation of 
Rule 102(e), the Commission may be exceeding the scope of its authority 
and engaging in the substantive regulation of the accounting 
profession.\67\ Similarly, a number of commenters suggested that 
adoption of a simple negligence standard would exceed the Commission's 
authority and encroach on the responsibilities of state boards of 
accountancy and professional organizations.
---------------------------------------------------------------------------

    \66\ The Checkosky decisions held that the Commission had not 
clearly articulated the ``improper professional conduct'' standard 
or the rationale for that standard. The Checkosky opinions did not 
decide the issue of the scope of the Commission's authority. One 
judge in Checkosky II wrote a separate opinion to state her 
disagreement with the dictum in Checkosky I questioning the 
Commission's authority to ensure that the professionals who practice 
before it adhere to minimal levels of competence.
    \67\ Checkosky I, 23 F.3d at 459 (opinion of Silberman, J.).
---------------------------------------------------------------------------

    Although the Commission believes that it has the authority to do 
so, the Commission is not adopting a ``simple'' or ``mere'' negligence 
standard. Instead, the Commission is adopting a standard under which 
two specific types of negligent conduct that result in a

[[Page 57170]]

violation of applicable professional standards are considered a future 
threat to the Commission's processes. The Commission is neither broadly 
regulating the accounting profession nor preventing accountants from 
functioning in numerous areas of their professions. Instead, the 
Commission is protecting the integrity and quality of its processes, 
and this it emphatically believes--in the public interest and for the 
protection of investors--it has the power to do.
    In addition, the standard adopted today imposes no new professional 
responsibilities on accountants. Instead, the final rule amendment 
permits the Commission to bring proceedings against accountants when 
their violations of professional standards threaten the Commission's 
processes. The Commission is not attempting to police accountants' 
conduct in any area other than as it affects the operation of the 
federal securities laws.
    One other judge in Checkosky I suggested that the Commission's 
authority to adopt a negligence standard under Rule 102(e)(1)(ii) might 
be limited by substantive provisions of the federal securities laws, 
such as the antifraud provision of Exchange Act Section 10(b).\68\ Some 
commenters contended that the Commission could not therefore adopt a 
definition of ``improper professional conduct'' that did not require 
that the accountant acted with ``scienter,'' the mental state required 
under the Exchange Act's antifraud provisions.\69\
---------------------------------------------------------------------------

    \68\ See Checkosky I, 23 F.3d at 469 (opinion of Randolph, J.).
    \69\ See, e.g., Arthur Andersen Comment Letter, at 2-3; KPMG 
Peat Marwick Comment Letter, at 6.
---------------------------------------------------------------------------

    The definition of ``improper professional conduct'' that the 
Commission adopts today does not require scienter in every instance. 
The Commission believes this is necessary because Rule 102(e) protects 
the integrity of the Commission's processes; it is not an enforcement 
remedy or a weapon against fraud.\70\ As noted above, accountants who 
engage in two specific kinds of negligent conduct can pose as great a 
threat to the Commission's processes as accountants who knowingly 
violate professional standards. As one commenter noted, ``the 
Commission's power to regulate professional standards should not be 
limited by the considerations of scienter that are appropriate in a 
jurisprudence built on common law definitions of fraud.'' \71\ In 
addition, as another commenter noted, the federal securities laws 
impose liability for negligent conduct, as well as for conduct 
undertaken with scienter.\72\ As this commenter noted, there are other 
policy reasons for the Commission to apply a negligence standard to 
accountants who practice before the Commission.\73\
---------------------------------------------------------------------------

    \70\ Commissioner Johnson's dissent misconstrues the distinction 
between an enforcement remedy and a remedy that protects the 
integrity of the Commission's processes. Rule 102(a) does not cease 
to protect the Commission's processes simply because those processes 
are designed, in turn, to protect investors or because the 
Commission, in deciding what type of proceeding to bring, may 
sometimes consider whether it is more appropriate to bring a Rule 
102(e) proceeding than an enforcement action. Rule 102(e) protects 
the integrity of the Commission's processes because it seeks to 
assure that professionals who prepare filings made with the 
Commission have the competence to prepare filings that comply with 
applicable requirements.
    \71\ See AFL-CIO Comment Letter, at 3.
    \72\ See Comment Letter of Joel Seligman, Dean and Samuel M. 
Fegtly Professor of Law, College of Law, University of Arizona, at 
2-3 (Aug. 11, 1998).
    \73\ Id. at 3.
---------------------------------------------------------------------------

E. A ``Good Faith'' Defense

    The Commission does not consider the subjective good faith of an 
accountant to be an absolute defense under Rule 102(e)(1)(ii).\74\ 
Subjective good faith is inconsistent with a finding of knowing or 
intentional, including reckless, conduct. Moreover, a Rule 102(e) 
proceeding based on the particular types of negligence covered in the 
final rule amendment does not require any subjective inquiry into the 
accountant's intent; subparagraphs (B)(1) and (B)(2) of the final rule 
amendment are objective standards. The Commission may, however, 
consider the accountant's good faith when determining what sanctions 
would be appropriate.
---------------------------------------------------------------------------

    \74\ See In re Haskins & Sells, Accounting Series Release No. 73 
(Oct. 30, 1952), [1937-1982 Transfer Binder] Fed. Sec. L. Rep. (CCH) 
para. 72,092 (June 30, 1982). Similarly, an auditor who is deceived 
by the client and commits an audit error in reliance upon the 
deception does not have an automatic defense. See generally In re 
Hope, Accounting and Auditing Enforcement Release No. 109A (Aug. 6, 
1986), 36 SEC Docket 663, 750-55 (Sept. 10, 1986). See also In re 
Ernst & Ernst, Accounting Series Rel. No. 248 (May 31, 1978), 14 SEC 
Docket 1276, 1301 and n. 71 (June 13, 1978). To the extent that 
dictum in In re Logan, 10 S.E.C. 982 (1942), can be read to provide 
for a good faith defense, the Commission believes the standard 
adopted today is preferable.
---------------------------------------------------------------------------

IV. Summary of Regulatory Flexibility Analysis

    A summary of the Initial Regulatory Flexibility Analysis (``IRFA'') 
on the proposed amendment to Rule 102(e) was published in the proposing 
release. The IRFA indicated that the proposed amendment would clarify 
the standard by which the Commission determines whether accountants 
have engaged in ``improper professional conduct.'' No comments were 
received on the IRFA. The Commission has prepared a Final Regulatory 
Flexibility Analysis (``FRFA'') in accordance with 5 U.S.C. 604 on the 
amendment to Rule 102(e). The following summarizes the FRFA.
    The FRFA discusses the need for the rule amendment. Rule 102(e) 
currently authorizes the Commission to censure an accountant or deny, 
temporarily or permanently, an accountant's privilege of appearing or 
practicing before the Commission, if the accountant lacks character or 
integrity, or has engaged in unethical or ``improper professional 
conduct.'' The existing rule does not define ``improper professional 
conduct.''
    In a recent opinion addressing the conduct of two accountants, the 
U.S. Court of Appeals for the District of Columbia Circuit found that 
the Commission's opinions in the case had not articulated clearly the 
``improper professional conduct'' element of the Rule. To address the 
court's concerns, the Commission is clarifying the Commission's 
standard for determining when accountants engage in ``improper 
professional conduct.''
    The FRFA explains that the rule amendment is designed to protect 
the integrity of the Commission's processes. By clarifying the 
standards applied in determining ``improper professional conduct,'' the 
amendment will help the Commission, its administrative law judges, and 
the courts apply the rule fairly and consistently. The amendment will 
also give practitioners additional guidance about the standards for 
proceedings under Rule 102(e).
    The FRFA explains that the notice of proposed rulemaking indicated 
how a copy of the IRFA could be obtained, and that no one requested a 
copy of the IRFA. The IRFA, and the summary of the IRFA that appeared 
in the notice of proposed rulemaking, also solicited comments 
generally, and in particular on the number of small entities that would 
be affected by the proposed amendment and the existence or nature of 
the effect. No commenters discussed either the IRFA generally or the 
number of small entities that would be affected by the proposed 
amendment.
    The FRFA also discusses the effect of the amendment on small 
entities. The FRFA states that approximately 1000 accounting firms can 
or do appear or practice before the Commission. While most of this 
practice is conducted by the ``Big Five'' firms, which are not small 
entities, many smaller firms do practice before the Commission. The 
Commission does not, however, collect information about revenues of 
accounting firms, which information generally is not made public by the

[[Page 57171]]

firms, and therefore cannot determine how many of these are small 
entities for purposes of the analysis. In any event, the proposed 
amendment should have little or no impact on small entities because the 
proposal simply clarifies the Commission's standard for determining 
when accountants engage in ``improper professional conduct.'' The 
Commission's standard provides a remedy for certain violations of the 
accountants' own professional standards and does not impose any new 
standards of conduct.
    The FRFA notes that the amendment would not impose any new 
reporting, recordkeeping or compliance requirements. The FRFA discusses 
the various alternatives considered to minimize the effect on small 
entities, including: (a) The establishment of differing compliance or 
reporting requirements or timetables that take into account the 
resources of small entities; (b) the clarification, consolidation or 
simplification of compliance and reporting requirements under the Rule 
for small entities; (c) the use of performance rather than design 
standards; and (d) an exemption from coverage of the Rule, or any part 
thereof, for small entities. The Commission believes it would be 
inconsistent with the purposes of the Rule to exempt small entities 
from the proposed amendment. Different compliance or reporting 
requirements for small entities are not necessary because the proposed 
amendment does not establish any new reporting, recordkeeping or 
compliance requirements. The proposed amendment is already designed to 
clarify the current standard employed in Rule 102(e)(1)(ii), and the 
Commission does not believe it is feasible to further clarify, 
consolidate or simplify the Rule for small entities. Finally, the 
proposal does use a performance standard, not a design standard, to 
specify what conduct is expected of accountants; the Commission does 
not believe different performance standards for small entities would be 
consistent with the purposes of the Rule.
    The FRFA notes that two commenters suggested that the proposed rule 
could have an adverse effect on small accounting firms and/or small 
public companies. The Commission believes that it has addressed the 
concern that a simple negligence standard might raise fees or 
discourage auditors from practice by raising the standard in the final 
amendment. Finally, the FRFA notes that one commenter contended that 
the proposed amendment would not impose a disproportionate impact on 
small entities, and that another commenter wrote that the level of 
competence expected of a professional must be an absolute standard, 
regardless of the entity's size.
    A copy of the FRFA may be obtained by contacting David R. 
Fredrickson, Office of the General Counsel, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

V. Cost-Benefit Analysis

    The Commission requested comments on any costs or benefits 
associated with the proposed amendment. No commenters offered any 
specific cost or benefit estimates. Several commenters, however, 
discussed the costs and benefits of the proposed amendment in general 
terms.
    One commenter suggested that the ``costs associated with the 
proposed amendment appear to outweigh its potential benefits,'' \75\ 
but offered no data to support the view. The commenter did describe the 
costs of the proposed amendment as ``costs associated with a decisional 
standard that fails to provide professionals with adequate notice of 
the conduct which could be subject to sanction,'' and costs created by 
the ``exposure of auditors to sanction based on a single negligent 
mistake,'' which the commenter believed ``would introduce an overly 
conservative bias into the financial reporting process.'' \76\
---------------------------------------------------------------------------

    \75\ See AICPA Comment Letter, at 30.
    \76\ Id. at 30-31.
---------------------------------------------------------------------------

    This commenter's concern that the proposed rule's use of a simple 
negligence standard would impose costs was shared by other commenters. 
Three commenters suggested that adoption of a simple negligence 
standard would, among other things, cause audit fees to increase.\77\ 
Likewise, one of these commenters and one other commenter suggested 
that the proposed rule's use of a negligence standard would discourage 
competent practitioners from pursuing careers in public company 
auditing.\78\
---------------------------------------------------------------------------

    \77\ See Comment Letter of R. Fogg (Aug. 12, 1998); Comment 
Letter of James Backus (Aug. 13, 1998) (``Backus Comment Letter''); 
Comment Letter of Kyle E. Carrick (Aug. 20, 1998) (``Carrick Comment 
Letter'').
    \78\ See BDO Seidman Comment Letter, at 9; Backus Comment 
Letter.
---------------------------------------------------------------------------

    The Commission does not believe that the final rule amendment 
imposes these costs. First, the Commission believes that the standard 
it adopts today defines with precision when an accountant's conduct 
will subject the accountant to Rule 102(e) proceedings. In fact, the 
clarification of the Commission's standard for ``improper professional 
conduct'' is one of the benefits of this final rule amendment. Second, 
these commenters' concern that accountants will be held liable for a 
single negligent mistake is addressed by the final rule amendment. As 
described above, the Commission is not adopting a standard that reaches 
single acts of simple negligence.
    One commenter argued that the proposed rule's costs outweighed its 
benefits because it applied to ``CPAs and CPA firms whose past errors 
are not necessarily a precursor of future substandard practice.'' \79\ 
The Commission believes that the final rule amendment only reaches 
accountants whose past violations demonstrate a lack of competence to 
practice before the Commission.
---------------------------------------------------------------------------

    \79\ See ABA Comment Letter, at 7; see also BDO Seidman Comment 
Letter, at 9 (stating that proposed amendment ``makes no distinction 
between professionals who have erred and those who are likely to err 
again'').
---------------------------------------------------------------------------

    According to this commenter, the ``elimination of individuals and 
firms whose audit services are unreliable will undoubtedly have a 
beneficial effect in preventing future investor losses.'' \80\ Weighed 
against this benefit, this commenter identified the costs of bringing 
Rule 102(e) proceedings and the costs ``associated with depriving the 
public of the services of qualified auditors.'' \81\ This commenter 
stated that the number of accounting firms providing auditing services 
to public companies has declined sharply in the last 20 years and that 
there is no assurance that a further decline might not lead to 
increased audit fees.\82\
---------------------------------------------------------------------------

    \80\ Id.; see also BDO Seidman Comment Letter, at 9.
    \81\ Id.
    \82\ ABA Comment Letter, at 7.
---------------------------------------------------------------------------

    These comments seem directed at the costs and benefits of Rule 
102(e) as a whole. The Commission only sought comment on the costs and 
benefits of its proposal to clarify ``improper professional conduct,'' 
not the costs and benefits of Rule 102(e). Moreover, the Commission has 
adopted a standard that is designed to reach only those accountants who 
lack competence to practice before the Commission. The rule amendment 
should not therefore ``deprive'' the public of the service of 
``qualified auditors.'' The Commission therefore believes that the 
costs and benefits described by the commenter will not be affected by 
the particular standard adopted.
    The Commission anticipates several benefits from the final rule 
amendment. The amendment will provide clearer guidance to accountants. 
Members of the accounting profession will better understand the 
standard the Commission uses to determine ``improper professional 
conduct.'' Also,

[[Page 57172]]

the clarified amendment will make it easier for the Commission, its 
administrative law judges and the courts to administer the Rule, which 
will further benefit the integrity of the Commission's processes. The 
Commission notes that its standard requires in the first instance that 
the accountant violate applicable professional standards. Therefore, 
the rule imposes no obligation that accountants are not already subject 
to. Rather, the amendment merely clarifies that when the Commission 
finds that an accountant has violated the applicable professional 
standards in circumstances meeting one of three standards of 
culpability, that accountant has engaged in ``improper professional 
conduct.'' The Commission also notes the existence of state accountancy 
boards, which can discipline accountants for violations of professional 
standards.
    In addition, the federal securities laws and state law causes of 
action may provide for sanctions against accountants for related 
conduct. Therefore, accountants are already subject to liability and 
disciplinary schemes that encourage accountants to comply with 
applicable professional standards. After careful consideration of the 
comments received, the Commission continues to believe that the 
amendment will impose no costs.

VI. Efficiency, Competition and Capital Formation

    Section 23(a)(2) of the Exchange Act requires the Commission to 
consider the impact of its rules on competition. Moreover, Section 2(b) 
of the Securities Act, Section 3(f) of the Exchange Act and Section 
2(c) of the Investment Company Act of 1940 (``Investment Company Act'') 
require the Commission, when engaged in rulemaking that requires a 
public interest finding, to consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition and 
capital formation.
    The Commission requested data on what effect, if any, the proposed 
amendment would have on efficiency, competition and capital formation. 
No specific data was received in response to this request. One 
commenter asserted that the rule as proposed would cause ``the steps 
and costs to take a company public'' to escalate.\83\ This commenter 
did not, however, provide any detail or explanation of why the proposed 
rule would cause this effect.
---------------------------------------------------------------------------

    \83\ See Carrick Comment Letter.
---------------------------------------------------------------------------

    The Commission anticipates no effect on capital formation or 
efficiency, as the rule amendment clarifies an existing standard. 
Further, because the rule change applies equally to all accountants who 
practice before the Commission, and because it clarifies an existing 
standard, there should be no anti-competitive effect. In any event, the 
Commission believes that any burden on competition imposed by this 
amendment is necessary and appropriate in furtherance of the purpose of 
the Exchange Act.

VII. Statutory Authority

    The Commission is adopting the amendment to the rule pursuant to 
its authority under Section 19(a) of the Securities Act, Section 23(a) 
of the Exchange Act, Section 20(a) of the Public Utility Holding 
Company Act of 1935, Section 319(a) of the Trust Indenture Act of 1939, 
Section 211(a) of the Investment Advisers Act of 1940 and Section 38(a) 
of the Investment Company Act.

Text of Amendment

List of Subjects in 17 CFR Part 201

    Administrative practice and procedure, Investigations, Securities.

    In accordance with the foregoing, Title 17, Chapter II of the Code 
of Federal Regulations is amended as follows:

PART 201--RULES OF PRACTICE

    1. The authority citation for Part 201, Subpart D continues to read 
as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77h-1, 77j, 77s, 77u, 
78c(b), 78d-1, 78d-2, 78l, 78m, 78n, 78o(d), 78o-3, 78s, 78u-2, 78u-
3, 78v, 78w, 79c, 79s, 79t, 79z-5a, 77sss, 77ttt, 80a-8, 80a-9, 80a-
37, 80a-38, 80a-39, 80a-40, 80a-41, 80a-44, 80b-3, 80b-9, 80b-11, 
and 80b-12 unless otherwise noted.

    2. Amend Sec. 201.102 by adding paragraphs (e)(1)(iv) to read as 
follows:


Sec. 201.102  Appearance and practice before the Commission.

* * * * *
    (e) Suspension and disbarment. (1) Generally.
    (iv) With respect to persons licensed to practice as accountants, 
``improper professional conduct'' under Sec. 201.102(e)(1)(ii) means:
    (A) Intentional or knowing conduct, including reckless conduct, 
that results in a violation of applicable professional standards; or 
(B) Either of the following two types of negligent conduct:
    (1) A single instance of highly unreasonable conduct that results 
in a violation of applicable professional standards in circumstances in 
which an accountant knows, or should know, that heightened scrutiny is 
warranted.
    (2) Repeated instances of unreasonable conduct, each resulting in a 
violation of applicable professional standards, that indicate a lack of 
competence to practice before the Commission.
* * * * *
    By the Commission.

    Dated: October 19, 1998.
Margaret H. McFarland,
Deputy Secretary.

Dissenting Statement of Commissioner Norman S. Johnson

    Although I have the deepest respect for my esteemed colleagues, I 
must dissent from the Commission's decision to issue today's 
release.\1\ Despite the good faith demonstrated by my colleagues 
throughout this difficult rulemaking process, I believe that the 
Commission is repeating past mistakes by again attempting to ``push the 
envelope'' of its permissible authority under Rule 102(e) of our Rules 
of Practice, which governs the ability of professionals to practice 
before the Commission. In my view, the Commission's release disregards 
the plain import of the two Checkosky decisions of the United States 
Court of Appeals for the District of Columbia Circuit.\2\ The release 
amends our Rule of Practice 102(e) so that an accountant's single act 
of negligence may amount, under some circumstances, to ``improper 
professional conduct,'' with the likely result of depriving an 
accountant of his or her livelihood.\3\
---------------------------------------------------------------------------

    \1\ The standard contained in today's release (the ``Standard'') 
was adopted at an open meeting of the Commission on September 23, 
1998. See SEC Defines ``Improper Professional Conduct'' by 
Accountants, 1998 WL 649370 (S.E.C.) (News Release Sept. 23, 1998).
    \2\ See Checkosky v. SEC, 23 F.3d 452 (D.C. Cir. 1994) 
(``Checkosky I''); Checkosky v. SEC, 139 F.3d 221 (D.C. Cir. 1998) 
(``Checkosky II''). The weight the Commission must attach to the 
views of the D.C. Circuit cannot be overstated. Under the 
jurisdictional provisions of the securities laws, every respondent 
in a Commission administrative proceeding has the option of 
appealing an adverse outcome to the D.C. Circuit. See, e.g., 15 
U.S.C. 77i(a) & 78y(a)(1).
    \3\ Amendment to Rule 102(e) of the Commission's Rules of 
Practice, Securities Act Release No. 33-7593 (October 19, 1998) (the 
``Release''). Before the recodification of the Commission's Rules of 
Practice in 1995, Rule 102(e) was formerly designated Rule 2(e). 
There are no substantive differences between the two rules. When 
directly quoting pre-1995 materials, I have left references to 
``Rule 2(e)'' intact; otherwise all references to the former Rule 
2(e) appear as ``Rule 102(e).''
---------------------------------------------------------------------------

    The more than 150 comment letters we have received--the 
overwhelming majority of them highly critical of the most important 
part of the proposal--demonstrate that Rule 102(e) is a matter of 
crucial importance to the accountants

[[Page 57173]]

who practice before the Commission.\4\ As Judge Randolph observed in 
---------------------------------------------------------------------------
Checkosky:

    \4\ See, e.g., Richard I. Miller, General Counsel & Secretary, 
American Institute of Certified Public Accountants (``AICPA''), 
Comment Letter (``CL'') 84; Arthur Andersen LLP, CL 98; Ernst & 
Young, LLP, CL 100; see also John M. Liftin, Chair, Committee on 
Federal Regulation of Securities, and Richard H. Rowe, Chair, 
Committee on Law and Accounting, American Bar Association, Section 
of Business Law (``ABA''), CL 81.
---------------------------------------------------------------------------

    A proceeding under Rule 2(e) threatens ``to deprive a person of 
a way of life to which he has devoted years of preparation and on 
which he and his family have come to rely.'' * * * It is of little 
comfort to an auditor defending against such charges that the 
Commission's authority is limited to suspending him from agency 
practice. For many public accountants such work represents their 
entire livelihood. Moreover, when one jurisdiction suspends a 
professional it can start a chain reaction.\5\

    \5\ Checkosky I, 23 F.3d at 479 (Randolph, J.) (quoting Henry J. 
Friendly, ``Some Kind of Hearing'', 123 U. Pa. L. Rev. 1267, 1297 
(1975)). Almost without exception, the comment letters bear out 
Judge Randolph's remarks, indicating that even if an accountant 
receives ultimate vindication, the mere bringing of charges of 
``improper professional conduct'' by the Commission may well have a 
``career-crippling'' effect. See Arthur Andersen, CL 98 at 1 & 5-6; 
see also, e.g., J.D. Fluno, Vice Chairman, W.W. Grainger, Inc., CL 
75; ABA, CL 81 at 11.
---------------------------------------------------------------------------

    As nature abhors a vacuum, so does the Commission: its intentions 
regarding the expansion of its Rule 102(e) authority have quickly 
become apparent. Within days of the adoption of the new standard on 
September 23, 1998, the Commission announced a major new initiative to 
address improper accounting practices.\6\ It is clear to me that the 
Commission intends for the expanded Rule 102(e) authority it has 
arrogated to itself in today's release to be an important enforcement 
weapon in this new initiative.
---------------------------------------------------------------------------

    \6\ Remarks by SEC Chairman Arthur Levitt, The ``Numbers Game'', 
New York University Center for Law and Business (Sept. 28, 1998) 
<http://www.sec.gov/news/speeches/spch220.txt>; SEC Press Release 
98-95 (Sept. 28, 1998) <http://www.sec.gov/news/press/98-95.txt> 
(announcing ``a major address on the state of accounting'' that will 
express Commission ``concern that the quality of financial reporting 
in corporate America is eroding and * * * [will] present an action 
plan that calls on the entire financial community to remedy the 
problem''); see Jube Shiver Jr., SEC to Crack Down on Inflated 
Earnings, L.A. Times, Sept. 29, 1998, at B1; see also Saul Hansell, 
S.E.C. Crackdown on Technology Write-Offs, N.Y. Times, Sept. 29, 
1998, at C1.
---------------------------------------------------------------------------

    The proponents of the amendment claim that it is significantly more 
protective of accountants than the standard set forth in the 
Commission's June 1998 proposing release.\7\ I disagree. I think that 
the proposed standard will not preclude the Commission from instituting 
Rule 102(e) proceedings for simple negligence.
---------------------------------------------------------------------------

    \7\ Proposed Amendment to Rule 102(e) of the Commission's Rules 
of Practice, Securities Act Release No. 7546, 1998 WL 311988 
(S.E.C.) (June 12, 1988), 63 Fed. Reg. 33305 (June 18, 1998) (the 
``Proposing Release'').
---------------------------------------------------------------------------

    For close to thirty years, I have followed the Commission's Rule 
102(e) proceedings indeed, long ago I wrote two articles on the 
subject.\8\ In my view, today's release represents another wrong turn 
in the Commission's Rule 102(e) jurisprudence. Previous wrong turns 
resulted in the two Checkosky opinions by the D.C. Circuit. Rule 102(e) 
differs fundamentally from the securities laws enforced by the 
Commission. The purpose of the securities laws is to protect investors, 
while the professed purpose of Rule 102(e) is to protect the integrity 
of the Commission's administrative processes. Under today's proposal, 
Rule 102(e) will be just another weapon in the Commission's enforcement 
arsenal. The use of Rule 102(e) as just another enforcement tool 
eliminates the underpinning of those few Court decisions that have 
upheld, in the most general terms possible, the Commission's ability 
even to promulgate Rule 102(e). Thus, the Commission's ability to bring 
any Rule 102(e) proceeding--under any standard, against even the most 
egregious violators--may now be in jeopardy. Even assuming the 
Commission has adequate authority to promulgate Rule 102(e), both 
Checkosky opinions indicate that the Commission lacks authority to 
adopt the sort of negligence standard contained in the Release. Under 
Checkosky, the Commission may only discipline professionals under Rule 
102(e) when scienter, including recklessness, is shown.\9\
---------------------------------------------------------------------------

    \8\ See Norman S. Johnson, The Dynamics of SEC Rule 2(e): A 
Crisis for the Bar, 1975 Utah L. Rev. 629; Norman S. Johnson, The 
Expanding Responsibilities of Attorneys in Practice Before the SEC: 
Disciplinary Proceedings Under Rule 2(e) of the Commission's Rules 
of Practice, 25 Mercer L. Rev. 637 (1974).
    \9\ See Robert D. Potts, Exchange Act Release No. 39126, 1997 WL 
690519 (S.E.C.), at *12 (Sept. 29, 1997) (Commissioner Johnson, 
concurring), aff'd on other grounds, 151 F.3d 810 (8th Cir. 1998); 
David J. Checkosky, Exchange Act Release No. 38183, 1997 WL 18303 
(S.E.C.), at *14 (Jan. 21, 1997) (Commissioner Johnson, dissenting), 
rev'd, Checkosky II, 139 F.3d 221.
---------------------------------------------------------------------------

    My long-standing interest in the Commission's Rule 102(e) 
jurisprudence, as well as my deep-rooted objections to the rule's 
expansive and improper uses, leads me to set forth my dissenting views 
at some length and in the following order:
     Because it is impossible to evaluate fairly today's 
release without consideration of the Commission's past missteps, I 
outline the history of Rule 102(e) in the first section.
     Next, in the second section, I discuss the Checkosky case, 
including the D.C. Circuit's two reversals of Commission opinions.
     In the third section, I explain the basis for my view that 
the Commission lacks legal authority even to promulgate Rule 102(e), 
and that, in any event, the Commission lacks the legal authority to 
adopt a negligence standard under Rule 102(e).
     In the fourth section, I demonstrate that the Standard is 
vague, and that it does not comply with the mandate of both Checkosky I 
and Checkosky II that we adopt a clear standard.
     In the fifth section, I set forth the various reasons 
why--even assuming adequate legal authority and clarity--it is not in 
the public interest for the Commission to adopt the Standard.
     Next, in the sixth section, I question whether the 
Commission gave adequate notice in its Proposing Release that it might 
adopt certain aspects of today's release.
     Finally, in the seventh section, I set forth the likely 
ways in which the Commission will seek to expand its Rule 102(e) 
authority in the future.

I. ``Administrative Oaks'' and ``Legislative Acorns'': A Brief 
History of Rule 102(E)

    In one of its landmark securities decisions restricting the growth 
of implied private actions under the federal securities laws, the 
Supreme Court remarked that Rule 10b-5 was ``a judicial oak which has 
grown from little more than a legislative acorn.'' \10\ The 
Commission's use of Rule 102(e) to regulate professional conduct might 
similarly be described as an ``administrative oak'' growing out of a 
``legislative acorn.'' There is no express statutory provision 
authorizing the Commission to discipline professionals; instead, a 
handful of courts have upheld the Commission's promulgation of Rule 
102(e) as impliedly proper because the rule is `` `reasonably related' 
to the purposes of the securities laws.'' \11\ I fully subscribe to the 
views of a distinguished predecessor, Commissioner Roberta Karmel, who 
observed in a Rule 102(e) case almost twenty years ago that ``[t]he 
administrative implication of

[[Page 57174]]

prosecutorial remedies under federal legislation is rife with the same 
evil'' possessed by ``judicial implication of private rights of 
action.'' \12\ In my view, the same disfavor the Supreme Court has 
enunciated towards implied private rights of action is equally 
applicable--and probably more so--to implied prosecutorial remedies 
such as those the Commission utilizes under Rule 102(e).\13\
---------------------------------------------------------------------------

    \10\ Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 732, 737 
(1975).
    \11\ Checkosky I, 23 F.3d at 455 (Silberman, J.) (quoting Touche 
Ross & Co. v. SEC, 609 F.2d 570, 582 (2d Cir. 1979)); see also, 
e.g., Daniel L. Goelzer & Susan Ferris Wyderko, Rule 2(e): 
Securities and Exchange Commission Discipline of Professionals, 85 
Nw. U. L. Rev. 652, 652 (1991) (lawyers and accountants ``are not 
subject to direct regulation under the federal securities laws,'' 
and their licensing and discipline is ``largely a matter committed 
to state licensing bodies and professional associations'').
    \12\ Keating, Muething & Klekamp, 47 S.E.C. 95, 111 (1979) 
(Commissioner Karmel, dissenting). Unfortunately, Commissioner 
Karmel dissented in the context of a settled enforcement action, so 
there was no opportunity for judicial review of the issues she 
raised. Several commentators have suggested that attempts to evade 
appellate review are a hallmark of the Commission's Rule 102(e) 
jurisprudence. See, e.g., Ann Maxey, SEC Enforcement Actions Against 
Securities Lawyers: New Remedies v. Old Policies, 22 Del. J. Corp. 
L. 537, 552-53 (1997); Richard W. Painter & Jennifer E. Duggan, 
Lawyer Disclosure of Corporate Fraud: Establishing a Firm 
Foundation, 50 S.M.U. L. Rev. 225, 271 (1996).
    \13\ See Touche Ross & Co. v. Redington, 442 U.S. 560 (1979); 
see also, e.g., Central Bank v. First Interstate Bank, 511 U.S. 164 
(1994); Keating, 47 S.E.C. at 111 & 116 n.35 (Commissioner Karmel, 
dissenting). The Supreme Court has approved the use of implied 
ancillary remedies, such as when the Commission seeks, e.g., 
disgorgement as a remedy in a typical enforcement action, but that 
situation seems readily distinguishable from Rule 102(e), in which 
both the cause of action and its remedy are implied. Cf. Franklin v. 
Gwinnett County Public Schools, 503 U.S. 50 (1992) (approving 
implied remedy to express cause of action).
---------------------------------------------------------------------------

    The Commission first promulgated Rule 102(e) in 1935.\14\ In its 
initial form, the rule contained a requirement that attorneys be 
admitted to practice before the Commission (as was then required of 
attorneys and accountants who sought to represent persons before the 
Internal Revenue Service).\15\ In 1938, however, the Commission struck 
the admission requirement, and since then the rule's only use has been 
to permit the Commission to censure, suspend or disbar 
professionals.\16\
---------------------------------------------------------------------------

    \14\ See Touche Ross & Co. v. SEC, 609 F.2d 570, 578 n.13 (2d 
Cir. 1979) (``Touche Ross''); Harold Marsh, Jr., Rule 2(e) 
Proceedings, 35 Bus. Law. 987, 987 (1980).
    \15\ Marsh, supra note 14, 35 Bus. Law. at 987.
    \16\ Id. Although Rule 102(e) reaches all types of professionals 
who might practice before the Commission, including engineers or 
expert witnesses, there have been only a few cases in the rule's 63-
year history that did not involve either a lawyer or an accountant.
---------------------------------------------------------------------------

    Although Rule 102(e) has caused a great deal of controversy since 
its inception,\17\ it was only used sparingly

[[Page 57175]]

during the first 35 years or so of its existence.\18\ Things changed in 
the early 1970's when the Commission embarked on its so-called 
``access'' theory of securities law enforcement.\19\ As a consequence 
of its belief that access to capital markets is controlled by a limited 
number of professionals, the Commission sought to achieve maximum 
deterrent value from its limited enforcement resources by suing the 
gatekeepers, rather than simply proceeding against the principal 
wrongdoers.\20\ Accordingly, the Commission brought wave-upon-wave of 
actions--including many Rule 102(e) administrative proceedings--against 
securities professionals, accountants and lawyers.\21\
---------------------------------------------------------------------------

    \17\ The following is a sampling of the literature discussing 
the Commission's use of Rule 102(e), the vast bulk of it 
extraordinarily critical--particularly when one discounts articles 
by Commission officials defending policies they themselves have 
helped formulate and administer. (I find it ironic that the number 
of law review articles discussing Rule 102(e) dwarfs the number of 
actual federal court decisions construing it by a factor of 
approximately 10 to 1). See, e.g., Roberta S. Karmel, Regulation by 
Prosecution: The Securities and Exchange Commission vs. Corporate 
America 173-83 (1982); ABA, Statement of Policy Adopted by ABA 
Regarding Responsibilities and Liabilities of Lawyers in Advising 
with Respect to the Compliance of Clients with Laws Administered by 
the Securities and Exchange Commission, 31 Bus. Law. 543, 545 
(1975); ABA Task Force on Rule 102(e) Proceedings, Report of the 
Task Force on Rule 102(e) Proceedings: Rule 102(e) Sanctions Against 
Accountants, 52 Bus. Law. 965 (1997); David H. Barber, Lawyer Duties 
in Securities Transactions Under Rule 2(e): The Carter Opinions, 
1982 B.Y.U. L. Rev. 513; Arthur Best, Shortcomings of Administrative 
Agency Lawyer Discipline, 31 Emory L.J. 535 (1982); Judah Best, In 
Opposition to Rule 2(e) Proceedings, 36 Bus. Law. 1815 (1981); 
Dennis J. Block & Charles J. Ferris, SEC Rule 2(e)--A New Standard 
for Ethical Conduct or an Unauthorized Web of Ambiguity, 81 Cap. U. 
L. Rev. 501 (1982); John C. Burton, SEC Enforcement and Professional 
Accountants: Philosophy, Objectives and Approach, 28 Vand. L. Rev. 
19 (1975); Michael P. Cox, Regulation of Attorneys Practicing Before 
Federal Agencies, 34 Case W. Res. L. Rev. 173 (1984); Joseph C. 
Daley & Roberta S. Karmel, Attorneys' Responsibilities: Adversaries 
at the Bar of the SEC, 24 Emory L.J. 747 (1975); Mitchell F. Dolin, 
SEC Rule 2(e): After Carter-Johnson: Toward a Reconciliation of 
Purpose and Scope, 9 Sec. Reg. L.J. 331 (1982); James R. Doty et 
al., The Professional as Defendant, in 23rd Annual Institute on 
Securities Regulation 681 (PLI Corp. Law & Practice Course Handbook 
Series No. B4-6978, 1991); Robert A. Downing & Richard L. Miller, 
Jr., The Distortion and Misuse of Rule 2(e), 54 Notre Dame Law. 774 
(1979); Robert W. Emerson, Rule 2(e) Revisited: SEC Disciplining of 
Attorneys since In re Carter, 29 Am. Bus. L.J. 155 (1991); Ralph C. 
Ferrara, Administrative Disciplinary Proceedings Under Rule 2(e), 36 
Bus. Law. 1807 (1981); Ted J. Fiflis, Choice of Federal or State Law 
for Attorneys' Professional Responsibility in Securities Matters, 56 
N.Y.U. L. Rev. 1236 (1981); Monroe H. Freedman, A Civil Libertarian 
Looks at Securities Regulation, 35 Ohio St. L.J. 280 (1974); Ray 
Garrett, Jr., Social Responsibility of Lawyers in Their Professional 
Capacity, 30 U. Miami L. Rev. (1976); Daniel L. Goelzer, The SEC and 
Opinion Shopping: A Case Study in the Changing Regulation of the 
Accounting Profession, 52 Brook. L. Rev. 1057 (1987); Stuart C. 
Goldberg, Policing Responsibilities of the Securities Bar: The 
Attorney-Client Relationship and the Code of Professional 
Responsibility--Considerations for Expertizing Securities Attorneys, 
19 N.Y.L.F. 221 (1973); Paul Gonson, Disciplinary Proceedings and 
Other Remedies Available to the SEC, 30 Bus. Law. 191 (1975); Kent 
Gross, Attorneys and Their Corporate Clients: SEC Rule 2(e) and the 
Georgetown ``Whistle Blowing'' Proposal, 3 Corp. L. Rev. 197 (1980); 
Samuel H. Gruenbaum, The SEC's Use of Rule 2(e) to Discipline 
Accountants and Other Professionals, 56 Notre Dame Law. 820 (1981); 
Samuel H. Gruenbaum & Marc I. Steinberg, Accountants' Liability and 
Responsibility: Securities, Criminal and Common Law, 13 Loy. L.A. L. 
Rev. 247 (1980); Stanley A. Kaplan, Some Ruminations on the Role of 
Counsel for a Corporation, 56 Notre Dame L. Rev. 873 (1981); Roberta 
S. Karmel, A Delicate Assignment: The Regulation of Accountants by 
the SEC, 56 N.Y.U. L. Rev. 959 (1981); Roberta S. Karmel, Attorneys' 
Securities Law Liabilities, 27 Bus. Law. 1153 (1972); John J. 
Kelleher, Scourging the Moneylenders from the Temple: The SEC, Rule 
2(e) and the Lawyers, 17 San Diego L. Rev. 501 (1980); Michael R. 
Klein, The SEC and the Legal Profession: Material Adverse 
Developments, 11 Inst. on Sec. Reg. (PLI) 604 (1979); Reynold Kosek, 
Professional Responsibility of Accountants and Lawyers Before the 
Securities and Exchange Commission, 72 L. Libr. J. 453 (1979); 
Steven C. Krane, The Attorney Unshackled: SEC Rule 2(e) Violates 
Clients' Sixth Amendment Right to Counsel, 57 Notre Dame L. Rev. 50 
(1981); Werner Kronstein, The Carter-Johnson Case: A Higher 
Threshold for SEC Actions Against Attorneys, 9 Sec. Reg. L.J. 293 
(1981); Michael R. Lanzarone, Professional Discipline: Unfairness 
and Inefficiency in the Administrative Process, 51 Fordham L. Rev. 
818 (1983); Philip H. Levy, Regulation of the Accounting Profession 
Through Rule 2(e) of the SEC's Rules of Practice: Valid or Invalid 
Exercise of Power?, 46 Brook. L. Rev. 1159 (1980); Frederick D. 
Lipman, The SEC's Reluctant Police Force: A New Role for Lawyers, 49 
N.Y.U. L. Rev. 437 (1974); Simon M. Lorne, The Corporate and 
Securities Adviser, the Public Interest, and Professional Ethics, 76 
Mich. L. Rev. 423 (1978); Lewis D. Lowenfels, Expanding Public 
Responsibilities of Securities Lawyers: An Analysis of the New Trend 
in Standard of Care and Priorities of Duties, 74 Colum. L. Rev. 412 
(1974); Harold L. Marquis, An Appraisal of Attorneys' 
Responsibilities Before Administrative Agencies, 26 Case W. Res. L. 
Rev. 285 (1976); Arthur F. Mathews, SEC Injunctive Proceedings 
Against Attorneys, 36 Bus. Law. 1819 (1981); Christine Neylon 
O'Brien, SEC Regulation of the Accounting Profession: Rule 2(e), 21 
Gonz. L. Rev. 675 (1985); L. Ray Patterson, The Limits of the 
Lawyer's Discretion and the Law of Legal Ethics: National Student 
Marketing Revisited, 1979 Duke L.J. 1251; Marvin G. Pickholtz, SEC 
Regulation of Professionals, 4 Rev. Fin. Serv. Reg. 165 (1988); 
Irving M. Pollack, The SEC Lawyer: Who is His Client and What are 
His Responsibilities?, 49 Geo. Wash. L. Rev. 453 (1981); Martin B. 
Robins, Policeman, Conscience or Confidant: Thoughts on the 
Appropriate Response of a Securities Attorney Who Suspects Client 
Violations of the Federal Securities Laws, 15 J. Marshall L. Rev. 
373 (1982); Michel Rosenfeld, The Transformation of the Attorney-
Client Privilege: In Search of an Ideological Reconciliation of 
Individualism, the Adversary System, and the Corporate Client's SEC 
Disclosure Obligations, 33 Hastings L.J. 495 (1982); Quinton F. 
Seamons, Inside the Labyrinth of the Elusive Standard Under the 
SEC's Rule 2(e), 23 Sec. Reg. L.J. 57 (1995); Morgan Shipman, The 
Need for SEC Rules to Govern the Duties and Civil Liabilities of 
Attorneys Under the Federal Securities Statutes, 34 Ohio St. L.J. 
231 (1973); George J. Siedel, Rule 2(e) and Corporate Officers, 39 
Bus. Law. 455 (1984); Marshall L. Small, An Attorney's 
Responsibilities Under Federal and State Securities Laws: Private 
Counselor or Public Servant?, 61 Cal. L. Rev. 1189 (1973); Mindy 
Jaffe Smolevitz, The Opinion Shopping Phenomenon: Corporate 
America's Search for the Perfect Auditor, 52 Brook. L. Rev. 1077 
(1987); Theodore Sonde, Professional Disciplinary Proceedings, 30 
Bus. Law. 157 (1975); Marc I. Steinberg, Attorney Liability Under 
the Securities Laws, 45 Sw. L.J. 711 (1991); Wallace L. Timmeny, 
Responsibilities of Lawyers in Connection with the Sale of Municipal 
Securities, 36 Bus. Law. 1799 (1981); Francis M. Wheat, The Impact 
of SEC Professional Responsibility Standards, 34 Bus. Law. 969 
(1979); David B. Wilkins, Who Should Regulate Lawyers?, 105 Harv. L. 
Rev. 799 (1992); Harold M. Williams, Corporate Accountability and 
the Lawyer's Role, 34 Bus. Law. 7 (1978); Marie L. Coppolino, Note, 
Rule 2(e) and the Auditor: How Should the Securities and Exchange 
Commission Define its Standard of Professional Conduct?, 63 Fordham 
L. Rev. 2227 (1995); Michael J. Crane, Note, Disciplinary 
Proceedings Against Accountants: The Need for a More Ascertainable 
Improper Professional Conduct Standard in the SEC's Rule 2(e), 53 
Fordham L. Rev. 351 (1984); Robert G. Day, Note, Administrative 
Watchdogs or Zealous Advocates? Implications for Legal Ethics in the 
Face of Expanded Attorney Liability, 45 Stan. L. Rev. 645, 673 
(1993); William Kenneth C. Dippel, Comment, Attorney Responsibility 
and Carter Under SEC Rule 2(e): The Powers That Be and the Fear of 
the Flock, 36 Sw. L.J. 897 (1982); Todd J. Flagel, Note, Securities 
Law: SEC Must Clarify Its Position as to the Level of Culpability 
that Must Be Shown to Constitute a Rule 2(e)(1)(ii) Violation By 
Accountants, 20 Dayton L. Rev. 1083 (1995); Note, Attorney 
Discipline by the SEC: 2(e) or not 2(e)?, 17 New Eng. L. Rev. 1267 
(1982); Note, The Duties and Obligations of the Securities Lawyer: 
The Beginning of a New Standard for the Legal Profession?, 1975 Duke 
L.J. 121; Note, SEC Disciplinary Proceedings Against Attorneys Under 
Rule 2(e), 79 Mich. L. Rev. 1270 (1981); Comment, SEC Disciplinary 
Rules and the Federal Securities Laws: The Regulation, Role and 
Responsibilities of the Attorney, 1972 Duke L.J. 969.
    \18\ As to the lawyers, the first Rule 102(e) proceeding was not 
brought until 1950, and only five cases were brought before 1960. 
See Keating, 47 S.E.C. at 112 (Commissioner Karmel, dissenting). The 
number of Rule 102(e) cases against accountants during from 1935 to 
1970 was also de minimis by comparison to recent years when the 
Commission has brought (according to statistics supplied by our 
Office of the Chief Accountant) an average of over 25 cases 
annually. See Marsh, supra note 14, 35 Bus. Law. at 987-89. 
Commentators seem to agree that, for various reasons, it is 
impossible to obtain accurate historical statistics regarding Rule 
102(e) proceedings, particularly for the period before 1975. See 
Emerson, supra note 17, 29 Am. Bus. L.J. at 173-83 (comprehensive 
effort to tabulate number and type of Rule 102(e) proceedings 
against lawyers through 1989); Marsh, supra note 14, 35 Bus. Law. at 
988.
    \19\ See, e.g., Burton, supra note 17, 28 Vand. L. Rev. at 19-
20; Simon M. Lorne & W. Hardy Callcott, Administrative Actions 
Against Lawyers Before the SEC, 50 Bus. Law. 1293, 1297 (1995); 
Maxey, supra note 12, 22 Del. J. Corp. L. at 549.
    \20\ Harvey L. Pitt & Karen L. Shapiro, Securities Regulation by 
Enforcement: A Look Ahead at the Next Decade, 7 Yale J. on Reg. 149, 
171-74 (1990).
    \21\ Id.; see also Emerson, supra note 17, 29 Am. Bus. L.J. at 
176 (for attorneys, peak years of Rule 102(e) enforcement activity 
were 1975 through 1977, when the Commission brought actions against 
53 attorneys and three law firms).
---------------------------------------------------------------------------

    The high water mark of the Commission's ``access'' theory was 
probably the National Student Marketing case.\22\ In National Student 
Marketing, the Commission brought an injunctive action that charged two 
nationally prominent law firms and several of their respective partners 
with aiding and abetting a securities fraud based on their alleged 
failure to take proper action when they ``permitted'' their clients to 
complete a merger that had received shareholder approval based on a 
proxy statement containing materially misleading financial 
information.\23\ The Commission's complaint alleged that the lawyers 
had a duty to insist that their clients resolicit proxies based on 
corrected information, and that, if the clients refused to follow this 
advice, the lawyers were required to resign and to report the alleged 
securities violations to the Commission.\24\ In practical terms, the 
Commission sought to make involuntary ``whistle-blowers'' or government 
agents out of private counsel by ``plac[ing] upon the lawyer a 
responsibility to investigate his clients'' activities in search for 
possible violations of law.'' \25\
---------------------------------------------------------------------------

    \22\ SEC v. National Student Marketing Corp., [1971-1972 
Transfer Binder] Fed. Sec. L. Rep. (CCH) para. 93,360, at 91,913 
(D.D.C. 1972) (complaint). Less than two weeks after the filing of 
the National Student Marketing complaint, the Wall Street Journal 
reported that it had become the ``best-read document since Gone With 
the Wind.'' Green, Irate Attorneys--A Bid to Hold Lawyers 
Accountable to Public Stuns, Angers Firms, Wall St. J., Feb. 15, 
1972, at 1, col. 1; see also Samuel H. Gruenbaum, Corporate/
Securities Lawyers: Disclosure, Responsibility, Liability to 
Investors, and National Student Marketing Corp., 54 Notre Dame Law. 
795 (1979).
    \23\ National Student Marketing, [1971-1972 Transfer Binder] 
Fed. Sec. L. Rep. (CCH) para. 93,360, at 91,913; see also Lorne, 
supra note 17, 76 Mich. L. Rev. at 455.
    \24\ SEC v. National Student Marketing Corp., [1971-1972 
Transfer Binder] Fed. Sec. L. Rep. (CCH) para. 93,360 at para. 
48(i).
    \25\ Milton V. Freeman, Recent Governmental Attacks on the 
Private Lawyer as an Infringement of the Constitutional Right to 
Counsel, 36 Bus. Law. 1791, 1792 (1981); see Cox, supra note 17, 34 
Case W. Res. L. at 204 (referring to attempts by Commission towards 
the ``enlistment of attorneys as agents of the government''); 
Wilkins, supra note 17, 105 Harv. L. Rev. at 836 (Commission has 
appeared to engage in ``overzealous enforcement'' actions against 
lawyers in order to encourage them to serve as watchdogs over their 
clients). Accord Mathews, supra note 17, 36 Bus. Law. at 1829; Marc 
I. Steinberg, Attorney Liability for Client Fraud, 1991 Colum. Bus. 
L. Rev. 1, 9.
---------------------------------------------------------------------------

    In discussing National Student Marketing, one Commissioner went so 
far as to state that, at least in the context of a securities 
transaction, a lawyer's role was ``more akin to that of an auditor,'' 
i.e., the lawyer would ``have to exercise a measure of independence'' 
from his client and would have to be ``acutely cognizant of his 
responsibility to the public who engage in securities transactions that 
would never have come about if not for his professional presence.'' 
\26\ Although the Commission brought National Student Marketing as an 
injunctive action in federal court, it soon changed its emphasis in 
professional discipline cases and increasingly brought them as 
administrative proceedings under Rule 102(e).\27\
---------------------------------------------------------------------------

    \26\ A.A. Sommer, The Emerging Responsibilities of the 
Securities Lawyer, [1973-1974 Transfer Binder] Fed. Sec. L. Rep. 
(CCH) para. 79,631, 83,686, at 83,689 to 83,690 (Jan. 24, 1974). I 
have the highest regard for former Commissioner Sommer, but I have 
long believed that this notion of lawyer as auditor is contrary to 
traditional canons of professional responsibility. See Johnson, 
supra note 8, 1975 Utah L. Rev. at 645-50.
    \27\ During the 1970's, federal courts increasingly placed 
limitations on the Commission's ability to bring suit and obtain 
injunctive relief. See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 
185, 197-198 (1976) (proof of scienter required in a Rule 10b-5 
action); SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 
98 (2d Cir. 1978) (``current judicial attitude toward the issuance 
of injunctions on the basis of past violations at the SEC's request 
has become more circumspect than in earlier days''). Convincing 
evidence exists demonstrating that the Commission increased its use 
of Rule 102(e) administrative proceedings after National Student 
Marketing as a means to circumvent these judicially-imposed 
limitations. See Downing & Miller, supra note 17, 54 Notre Dame Law. 
at 783-85 (quoting June 1976 memorandum from Commission's General 
Counsel to Commission's Chairman suggesting that the Commission 
might appropriately bring Rule 102(e) actions in situations in which 
a professional's conduct would not satisfy the Hochfelder 
requirement of scienter for Rule 10b-5 actions); see also, e.g., 
Arthur Best, supra note 17, 31 Emory L.J. at 550 (lesser negligence 
standard ``may explain why SEC chose'' to bring Rule 102(e) action, 
rather than injunctive action against major accounting firm, and 
this option ``can be viewed either as an advantage of the 
administrative process or as a dangerous discretionary weapon that 
ought not to be available to the agency''); James P. Hemmer, 
Resignation of Corporate Counsel: Fulfillment or Abdication of Duty, 
39 Hastings L.J. 641, 650 (1988) (``The unwillingness of the courts 
to issue injunctions when there is no likelihood of recurring 
violation * * * is at least one of the principal factors in the 
SEC's increasing use of rule 2(e) proceedings to govern the 
discipline of professionals.'').
---------------------------------------------------------------------------

    Although National Student Marketing involved charges against law 
firms and individual lawyers, the Commission did not limit its 
overreaching to the legal profession--indeed, one contemporaneous 
commentary referred to accountants as the ``most actively besieged 
profession'' under Rule 102(e).\28\ In SEC v. Arthur Young & Co., a 
case arising from the activities of an oil and gas venture promoter 
over a seven-year period in the 1960's, the Commission charged a 
nationally prominent accounting firm and the responsible auditors with 
committing or aiding and abetting securities fraud.\29\ Because the 
case predated the Supreme Court's decision requiring the Commission to 
prove scienter in its Rule 10b-5 enforcement cases,\30\ the Ninth 
Circuit assumed that ``negligence, rather than scienter, constitutes 
the standard by which an accountant's or auditor's

[[Page 57176]]

performance must be measured.''\31\ Before the district court, the 
Commission argued that the firm and its auditors performed their work 
``with blinders on'' and that they should have done ``more'' to reveal 
the risks to those who invested in the ventures.\32\ On appeal, the 
Commission apparently argued that the accountants had failed to perform 
their audit in a manner that would have revealed to ``an ordinary 
prudent investor, who examined the * * * audits or financial 
statements, a reasonably accurate reflection of the financial risks * * 
*.'' \33\ The Ninth Circuit rejected both formulations of the 
Commission's argument, noting:

    \28\ See Downing & Miller, supra note 17, 54 Notre Dame Law. at 
775 n.6; see also id. at 774 (``Recent 2(e) proceedings against 
accountants demonstrate that the SEC has converted the rule from one 
designed to serve the limited salutary purpose of exercising 
disciplinary authority over the incompetent, unethical or dishonest 
accounting practitioner to a rule which has effectively been 
utilized to pervasively regulate accounting firms and the profession 
as a whole.'').
    \29\ 590 F.2d 785, 786 (9th Cir. 1979).
    \30\ Aaron v. SEC, 446 U.S. 680 (1980).
    \31\ 590 F.2d at 787.
    \32\ 590 F.2d at 787.
    \33\ 590 F.2d at 787-88.
---------------------------------------------------------------------------

    To accept the SEC's position would go far toward making the 
accountant both an insurer of his client's honesty and an 
enforcement arm of the SEC. We can understand why the SEC wishes to 
so conscript accountants. Its frequently late arrival on the scene 
of fraud and violations of the securities laws almost always suggest 
that had it been there earlier with the accountant it would have 
caught the scent of wrong-doing and, after an unrelenting hunt, 
bagged the game. What it cannot do, the thought goes, the accountant 
can and should. The difficulty with this is that Congress has not 
enacted the conscription bill that the SEC seeks to have us fashion 
and fix as an interpretive gloss on existing securities laws.\34\

    \34\ 590 F.2d at 788.
---------------------------------------------------------------------------

To be sure, the Commission's attitude towards the conscription of 
accountants--and their purported wearing of ``blinders,'' or failures 
to observe and respond to ``red flags''--persists to this day.\35\
---------------------------------------------------------------------------

    \35\ In a later case upholding disciplinary sanctions imposed by 
the Commission on an accountant under Rule 102(e), the Ninth Circuit 
purported to distinguish Arthur Young. See Davy v. SEC, 792 F.2d 
1418, 1422 (9th Cir. 1986). I confess to being confused by Davy--one 
would think that if the Commission were barred from directly 
``conscript[ing] accountants'' under the substantive securities 
laws, it would also be barred from indirectly ``conscript[ing] 
accountants'' under Rule 102(e). The real distinction seems to be 
that Davy, unlike Arthur Young, involved truly egregious scienter-
based misconduct by an accountant. See 792 F.2d at 1422 (referring 
to Commission finding, supported by ``substantial evidence,'' that 
the accountant ``knowingly participated in the fraud practice by 
[the issuer] on the investing public''). In any event, Davy does not 
support the Commission's adoption of the Standard, because the Court 
went to great lengths to limit its holding:
    We do not consider whether cases can arise in which the SEC in 
Rule 2(e) matters exceeds its proper jurisdictional boundaries. The 
precise reach of the SEC in these situations has not been defined 
and we leave that task for a future case which implicates that 
question directly.
    Id.; see also id. (``there may be cases where the SEC should not 
be empowered to determine the standards by which accountants, or 
attorneys for that matter, are to be judged''; ``[w]e pretermit any 
discussion of the SEC's power to determine standards for discipline 
under Rule 2(e) until we have the issue squarely before us'').
---------------------------------------------------------------------------

    Many legal scholars and members of the securities bar and industry, 
myself among them, decried the Commission's overreaching in National 
Student Marketing, Arthur Young and similar cases.\36\ One commentary 
described the Commission's efforts, colorfully but accurately, as a `` 
`reign of terror' on broker-dealers, accountants and attorneys.'' \37\ 
Indeed, for more than twenty-five years, the Commission's attempts to 
set standards for professional conduct, under Rule 102(e) and 
otherwise, have caused much dissension on the Commission itself.\38\ 
The roster of distinguished former Commissioners who have expressed 
serious doubts about the Commission's expansive uses of Rule 102(e) and 
other attempts to set professional standards includes: Edward H. 
Fleischman, Roberta S. Karmel, Philip Lochner, Jr., Richard Y. Roberts, 
and Steven M.H. Wallman.\39\
---------------------------------------------------------------------------

    \36\ See, e.g., Daley & Karmel, supra note 17, 24 Emory L.J. 
747; Downing & Miller, supra note 17, 54 Notre Dame Law. 774; 
Freeman, supra note 25, 36 Bus. Law. 1791; Johnson, supra note 8, 
1975 Utah L. Rev. 629; Johnson, supra note 8, 25 Mercer L. Rev. 637.
    \37\ Dennis J. Block & Jonathan M. Hoff, SEC Moves Against 
Attorneys Under the Remedies Act, N.Y.L.J., Sept. 23, 1993, at 5 
(quoting Harvey L. Pitt & Dixie L. Johnson, Justice Delayed, Justice 
Denied: Observations on the SEC's `Kern' Decision, N.Y.L.J., July 
11, 1991, at 5).
    \38\ See, e.g., Keating, 47 S.E.C. at 109 (Commissioner Karmel, 
dissenting); Richard E. Brodsky, P.A., CL 54.
    \39\ Keating, 47 S.E.C. at 112 (1979) (Commissioner Karmel, 
dissenting); see also Potts, 1997 WL 690519 (S.E.C.), at *17 
(Commissioner Wallman, dissenting); David J. Checkosky, 50 S.E.C. 
1180, 1198 (1992) (Commissioner Roberts, concurring in part and 
dissenting in pertinent part); Allied Stores Corp., 1987 SEC LEXIS 
4306, at *19 (June 29, 1987) (Commissioner Fleischman, dissenting); 
Richard Y. Roberts, CL 18.
    It appears that the Rule 102(e) skeptics on the Commission have 
not always been in the minority. See Potts, 1997 WL 690519 (S.E.C.), 
at *12 (Commissioner Johnson, concurring) (noting that the 
Commission was ``evenly split two-two'' on the issue of whether a 
single act of mere negligence was sufficient for liability under 
Rule 102(e)); see also Checkosky I, 23 F.3d at 487 (discussing media 
reports that, at a preliminary stage, three Commissioners had voted 
to overturn the `` `harsh sanction' '' imposed by the Administrative 
Law Judge); David J. Checkosky, 50 S.E.C. at 1182 (denying 
respondents' ``factual assertion that * * * the Commission had 
[earlier] rendered a final opinion in this case and improperly 
refused to publish it'').
---------------------------------------------------------------------------

    Much of the criticism of the Commission's efforts in this area has 
focussed on two factors. First, neither the Commission nor its 
administrative law judges (``ALJ's'') have a statutory mandate to 
establish ethical standards nor any special expertise in the area of 
professional responsibility; second, the threat of disciplinary action 
might well intimidate and interfere with the exercise of independent 
professional judgment and, as to lawyers, might deprive clients of 
their constitutional right to counsel.\40\ These fears were far from 
academic: the National Student Marketing case clearly affected the 
ability and willingness of the securities bar to take zealous positions 
before the Commission.\41\ According to an article co-written by the 
then-General Counsel of the Commission, the controversy caused by 
National Student Marketing and similar cases became so heated that it 
affected ``the Commission's ability to carry out its statutory 
mandates,'' because it lessened the necessary cooperation and trust 
between the Commission, its staff and the securities bar and 
industry.\42\
---------------------------------------------------------------------------

    \40\ See Keating, 47 S.E.C. at 112-17 & n.31 (1979) 
(Commissioner Karmel, dissenting); see also, e.g., Kivitz v. SEC, 
475 F.2d 956, 962 (D.C. Cir. 1973) (reversing Commission finding of 
liability in Rule 102(e) disbarment case; declining to give 
Commission any deference in matters of alleged professional 
misconduct); Judah Best, supra note 17, 36 Bus. Law. at 1817; 
Freeman, supra note 25, 36 Bus. Law. at 1792-94; Lorne & Callcott, 
supra note 19, 50 Bus. Law. at 1301-03.
    \41\ Cf. Lorne, supra note 17, 76 Mich. L. Rev. at 455-56 
(recounting post-National Student Marketing incident in which a 
lawyer, unable to compel disclosure, resigned from his law firm and 
reported the matter to the SEC; after the disclosure was made, a 
class action lawsuit followed that was settled upon payment of 
$785,000, $625,000 of which came from the lawyer's former firm, and 
only $160,000 from the client).
    \42\ Lorne & Callcott, supra note 19, at 1300-01 (referring to 
actions against lawyers).
---------------------------------------------------------------------------

    In response to the well-deserved firestorm of criticism caused by 
National Student Marketing and similar cases, the Commission 
retreated.\43\ As to lawyers, the Commission announced that it would 
commence Rule 102(e) actions only where it could demonstrate scienter 
and that it would cease bringing ``original'' Rule 102(e) actions 
(i.e., the Commission would only bring an administrative proceeding 
against a lawyer if a federal court first determined that the lawyer 
had violated the federal securities laws).\44\ As to accountants, the

[[Page 57177]]

situation was less clear, but, at least for a time, the Commission 
seemed less aggressive in bringing Rule 102(e) actions against them as 
well.\45\
---------------------------------------------------------------------------

    \43\ Lorne & Callcott, supra note 19, at 1303-04; Pitt & 
Shapiro, supra note 20, 7 Yale J. on Reg. at 174; see also Freeman, 
supra note 25, 36 Bus. Law. at 1792.
    \44\ William R. Carter, 47 S.E.C. 471, 511-12 (1981); Lorne & 
Callcott, supra note 19, at 1303-04 (referring to a speech given by 
the Commission's then-General Counsel: Edward Greene, Lawyer 
Disciplinary Proceedings Before the Securities and Exchange 
Commission, [1981-1982 Transfer Binder] Fed. Sec. L. Rep. (CCH) 
para. 83,089, at 84,800 (Jan. 13, 1982)). In 1988, the Commission 
ratified Mr. Greene's speech in a release that stated: ``the 
Commission, as a matter of policy, generally refrains from using its 
administrative forum to conduct de novo determinations of 
professional obligations of attorneys.'' Disciplinary Proceedings 
Involving Professionals Appearing or Practicing Before the 
Commission, Securities Act Release No. 6783, 53 Fed. Reg. 26,427, 
26,431 n.30, 1988 WL 278442 (F.R.) (July 13, 1988); see also id. 
(referring to Commission practice of generally instituting Rule 
102(e) proceedings ``only where the attorney's conduct has already 
provided the basis for a judicial or administrative order finding a 
securities law violation in a non-Rule 2(e) proceeding'').
    \45\ Pitt & Shapiro, supra note 20, 7 Yale J. on Reg. at 174.
---------------------------------------------------------------------------

    In the late 1980's, however, Rule 102(e) actions against 
accountants became more of a focal point for the Commission.\46\ In 
1988, the Commission amended Rule 102(e) to create a presumption that 
disciplinary proceedings would be public rather than private--
previously Rule 102(e) proceedings only became public if sanctions were 
imposed.\47\ In addition, as an enforcement adjunct to combat 
``financial fraud,'' the Commission stepped up its use of Rule 102(e) 
to bring charges of ``improper professional conduct'' against the 
auditors of public companies.\48\ It was in this context that the 
Commission instituted administrative proceedings under Rule 102(e) 
against two accountants, David J. Checkosky and Norman A. Aldrich.\49\
---------------------------------------------------------------------------

    \46\ Goelzer & Wyderko, supra note 11, 85 Nw. U.L. Rev. at 653.
    \47\ Rule 102(e)(7); see Disciplinary Proceedings Involving 
Professionals Appearing or Practicing Before the Commission, 
Securities Act Release No. 6783, 53 Fed. Reg. 26,427, 1988 WL 278442 
(F.R.) (July 13, 1988).
    \48\ Goelzer, supra note 17, 52 Brook. L. Rev. at 1061; see also 
infra note 135.
    \49\ David J. Checkosky, Order Instituting Private Proceedings, 
File No. 3-6776 (Nov. 12, 1987).
---------------------------------------------------------------------------

II. The Checkosky Decisions

    Checkosky and Aldrich, partners at one of the nation's preeminent 
accounting firms, were the engagement partner and audit manager in 
connection with audits of the Savin Corporation from 1981 to 1984.\50\ 
The Commission brought a Rule 102(e) proceeding against them in 1987, 
and in 1992 affirmed an ALJ's finding of ``improper professional 
conduct.'' \51\ In its initial opinion, the Commission found that 
Savin's financial statements were false in that the company improperly 
capitalized certain expenses for research and development rather than 
recording them in their entirety as expenses in the years incurred.\52\ 
These violations were based on a finding that the auditors, in 
violation of Generally Accepted Auditing Standards (``GAAS''), had 
improperly permitted Savin to capitalize these expenditures and falsely 
certified that Savin's financial statements set forth its financial 
condition in accordance with Generally Accepted Accounting Principles 
(``GAAP'').\53\
---------------------------------------------------------------------------

    \50\ David J. Checkosky, 50 S.E.C. 1180, 1180-81 (1992).
    \51\ 50 S.E.C. at 1180-81.
    \52\ 50 S.E.C. at 1181.
    \53\ 50 S.E.C. at 1181.
---------------------------------------------------------------------------

    Commissioner Roberts concurred in the majority's finding that 
respondents violated GAAS and misapplied GAAP, but dissented from the 
finding that these errors amounted to ``improper professional conduct'' 
under Rule 102(e).\54\ In Commissioner Roberts' view, respondents' 
conduct did not provide a sufficient basis for a finding that they 
would threaten the Commission's processes.\55\
---------------------------------------------------------------------------

    \54\ 50 S.E.C. at 1198 (Commissioner Roberts, concurring in part 
and dissenting in part).
    \55\ 50 S.E.C. at 1198 & 1212-14.
---------------------------------------------------------------------------

    In Checkosky I, the D.C. Circuit remanded the case because it was 
unable to discern from the Commission's opinion the basis for its 
action other than the finding that the accountants had violated GAAS 
and falsely certified that the financial statements set forth the 
financial condition of the company in accordance with GAAP.\56\ There 
was no opinion of the Court, and each of the three judges (Judge 
Silberman, Judge Randolph and a district court judge sitting by 
designation, Judge Reynolds) issued a separate opinion.
---------------------------------------------------------------------------

    \56\ 23 F.3rd at 454.
---------------------------------------------------------------------------

    Judges Silberman and Randolph both questioned the Commission's 
ability to impose sanctions under Rule 102(e) for misconduct not rising 
to the level of scienter, i.e., misconduct that is only negligent.\57\ 
In Judge Randolph's view, the Commission's authority under Rule 2(e) 
``must rest on and be derived from the statutes it administers,'' such 
as Section 10(b) of the Exchange Act that requires scienter.\58\ Judge 
Randolph also extensively discussed a 1981 Commission decision, William 
R. Carter, which he regarded--correctly, in my view--as ``the 
Commission's most comprehensive discussion of the history, purpose and 
operation of Rule 2(e),'' that rejected a negligence standard in case 
involving lawyers.\59\ Judge Randolph endorsed the reasoning of Carter: 
``if a securities lawyer is to exercise his `best independent judgment 
* * * he must have the freedom to make innocent--or even, in certain 
cases, careless--mistakes without fear of [losing] the ability to 
practice before the Commission.' '' \60\ In Judge Randolph's view, the 
exercise of independent professional judgment was equally crucial to 
accountants, and this consideration would preclude the Commission from 
adopting a negligence standard, even if only applicable to accountants, 
under Rule 102(e).\61\
---------------------------------------------------------------------------

    \57\ Senior District Judge Reynolds dissented from the circuit 
judges' conclusion that ``improper professional conduct'' under Rule 
102(e) required proof of scienter. 23 F.3d at 493-95.
    \58\ See 23 F.3d at 466 & 468-69.
    \59\ See 23 F.3d at 484; see also 23 F.3d at 480-87 (citing 
William R. Carter, 47 S.E.C. 471 (1981)).
    \60\ 23 F.3d at 484 (ellipsis and brackets in original; quoting 
Carter, 47 S.E.C. at 504).
    \61\ See 23 F.3d at 483-87.
---------------------------------------------------------------------------

    Judge Silberman likewise questioned the Commission's ability to 
adopt a negligence standard. For instance, Judge Silberman explained 
that:

    If the purpose of Rule 2(e) is to protect the integrity of 
administrative processes, then sanctions for improper professional 
conduct under 2(e)(1)(ii) are permissible only to the extent that 
they prevent the disruption of proceedings. Punishment for mere 
negligence, so the argument goes, extends beyond this realm of 
protective discipline into general regulatory authority over a 
professional's work.\62\
---------------------------------------------------------------------------

    \62\ 23 F.3d at 456.

Judge Silberman similarly suggested that the Commission could not 
legitimately adopt a negligence standard under Rule 102(e) because that 
might amount to ``a de facto substantive regulation of the 
profession.'' \63\ Judge Silberman further indicated that the adoption 
by the Commission of a negligence standard, given its previous contrary 
precedent, might be arbitrary and capricious.\64\
---------------------------------------------------------------------------

    \63\ 23 F.3d at 459.
    \64\ 23 F.3d at 460; see also 23 F.3d at 458-59 (referring to 
Carter, 47 S.E.C. 471, and Kenneth N. Logan, 10 S.E.C. 982 (1942)).
---------------------------------------------------------------------------

    On remand, the Commission's majority opinion did not directly 
address the mental state question posed by the Court.\65\ Instead, the 
majority found that the accountants had behaved recklessly, but at the 
same time insisted that any deviation from GAAP or GAAS, including 
purely negligent ones, could violate Rule 102(e), and that the 
accountants' recklessness was relevant only to the choice of 
sanctions.\66\ I dissented from the Commission's second Checkosky 
opinion because I believed that ``improper professional conduct'' 
required proof of scienter.\67\
---------------------------------------------------------------------------

    \65\ David J. Checkosky, 1997 WL 18303 (S.E.C.) (Jan. 21, 1997).
    \66\ 1997 WL 18303 (S.E.C.), at *10.
    \67\ 1997 WL 18303 (S.E.C.), at *14.
---------------------------------------------------------------------------

    On appeal in Checkosky II, the D.C. Circuit again reversed, and 
scolded the Commission, in scathing terms, for its failure to heed the 
dictates of Checkosky I.\68\ The Court found that, the prior remand 
notwithstanding, the Commission had again failed to offer an adequate 
explanation of Rule 2(e)(1)(ii), but had ``voic[ed] instead a 
multiplicity

[[Page 57178]]

of inconsistent interpretations.'' \69\ Because of the Commission's 
``persistent failure to explain itself'' and ``the extraordinary 
duration of these proceedings,'' the Court declined to give the 
Commission a third chance, and instead invoked the exceedingly rare 
remedy of remanding the case with instructions to dismiss.\70\
---------------------------------------------------------------------------

    \68\ E.g., 139 F.3d at 222.
    \69\ 139 F.3d at 222.
    \70\ 139 F.3d at 222; see also id. at 227.
---------------------------------------------------------------------------

    In an opinion truly remarkable for the criticism heaped on the 
Commission, the Court agreed with respondents' contention that the 
Commission had again ``failed to articulate an intelligible standard 
for `improper professional conduct' under Rule 2(e)(1)(ii).'' \71\ The 
Court noted that not only was the Commission's 1997 opinion unclear, 
but that, ``[i]n something of a tour de force,'' it managed ``to both 
embrace and reject standards of (1) recklessness, (2) negligence and 
(3) strict liability--or so a careful (and intrepid) reader could 
find.'' \72\ The Court also enumerated numerous contradictions between 
the Commission's opinion and its appellate brief and oral argument.\73\ 
In the Court's view, the Commission's failure to adopt an intelligible 
negligence standard was so lacking that the Commission had violated 
``[e]lementary administrative law norms of fair notice and reasoned 
decisionmaking.'' \74\ Referring to one part of the Commission's 1997 
opinion, the Court sarcastically observed ``[i]n the space of four 
short sentences this passage achieves impressive feats of ambiguity.'' 
\75\ The Court continued on, remarking: ``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.''\76\
---------------------------------------------------------------------------

    \71\ 139 F.3d at 223.
    \72\ 139 F.3d at 223.
    \73\ 139 F.3d at 223-24.
    \74\ 139 F.3d at 224.
    \75\ 139 F.3d at 225.
    \76\ 139 F.3d at 225.
---------------------------------------------------------------------------

    In a passage of great portent to today's release, the Court stated 
that the Commission's instrumental good intentions alone will not 
suffice:

    However 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).\77\
---------------------------------------------------------------------------

    \77\ 139 F.3d at 225.

As in Checkosky I, the Court questioned the Commission's ability to 
adopt a negligence standard under Rule 102(e).\78\ The Court appeared 
to reaffirm its previous statements about the limits of the 
Commission's authority in disciplining professionals subject to Rule 
102(e), remarking that ``adoption of a negligence standard might be 
ultra vires'' because it might amount to ``a back-door expansion of 
[the Commission's] regulatory oversight powers.'' \79\ On this last 
point, Judge Henderson wrote a two-sentence concurrence to express her 
disagreement with the majority (Judge Williams, who wrote the opinion, 
and Chief Judge Edwards).\80\
---------------------------------------------------------------------------

    \78\ 139 F.3d at 225.
    \79\ Id. (citing Checkosky I, 23 F.3d at 459 (Silberman, J.)).
    \80\ 139 F.3d at 227. Unlike the majority, Judge Henderson 
apparently believed that the Commission did have the authority to 
adopt a negligence standard under Rule 102(e). Id. (the Commission, 
like every regulatory body, ``possesses--and must possess--authority 
to maintain the professional standards of its practitioners'').
---------------------------------------------------------------------------

III. The Commission Lacks the Authority to Promulgate Rule 102(E) 
or, at the Least, Lacks the Authority To Adopt the Proposed 
Standard

    As a result of this rulemaking process, I have reexamined the 
Commission's rationale for promulgating Rule 102(e), that is, the rule 
has a remedial purpose to protect the integrity of the Commission's 
administrative processes. This reexamination leads me to the conclusion 
that Rule 102(e) does not have that remedial purpose, rather it is or 
has become just another weapon in the Commission's enforcement arsenal. 
Rule 102(e)'s status as an enforcement tool removes the basis relied 
upon by those few courts that have upheld the Commission's ability even 
to promulgate Rule 102(e). Furthermore, even assuming the authority to 
promulgate Rule 102(e) in some form, the Commission may not adopt the 
negligence standard set forth in today's release.
    In addition to rendering a single negligent act, under some 
circumstances, ``improper professional conduct,'' the other two parts 
of the Standard create liability for: intentional, knowing or reckless 
conduct; and a pattern of negligent acts. As the Release correctly 
notes, most commenters agreed with these parts of the proposal.\81\ 
Assuming the Commission has the authority to promulgate Rule 102(e), I 
support the intentional or reckless part of the amendment without 
reservation. As to that part addressing a pattern of negligence, I 
would generally reach the same result as the majority, but through a 
different analysis. Assuming adequate authority, the Commission may 
appropriately bring a charge of ``improper professional conduct'' under 
Rule 102(e) only if the pattern of negligence supports an inference 
that the accountant acted recklessly.\82\ In any event, because of the 
natural tendency towards the path of least resistance--towards proving 
one's case the by the easiest method possible--I think that most of the 
Rule 102(e) cases brought under the new standard will surely be brought 
under the single negligent act provision.
---------------------------------------------------------------------------

    \81\ See Release at 3, 15 & 26.
    \82\ Compare Potts, 1997 WL 690519 (S.E.C.), at *12 & n.1 
(Commissioner Johnson, concurring) with Potts, 1997 WL 690519 
(S.E.C.), at *17 (Commissioner Wallman, dissenting).
---------------------------------------------------------------------------

A. Rule 102(e) Has Become Another Weapon in the Commission's 
Enforcement Arsenal

    In the Release, the Commission explains its refusal to adopt a 
scienter standard because ``Rule 102(e) protects the integrity of the 
Commission's processes; it is not an enforcement remedy or a weapon 
against fraud.'' \83\ The Commission also insists that ``the rule is 
remedial and not punitive in nature.'' \84\ I disagree with the first 
assertion, and think the second assertion is contrary to controlling 
law in the D.C. Circuit. Although I have come to the conclusion that 
Rule 102(e) is overly broad, as a structural matter, I do wish to 
emphasize my view that the Commission, like any adjudicative body, may 
legitimately adopt a disciplinary rule designed to redress 
contemptuous, disruptive or obstructionist behavior by advocates who 
appear in actual proceedings before us.\85\ But Rule 102(e) is not such 
a permissible rule. I am, of course, aware that several courts have 
accepted the Commission's professed rationale about the need to protect 
its administrative

[[Page 57179]]

processes.\86\ In my view, however, today's amendment--combined with 
the Commission's recently announced crackdown on improper accounting 
practices, as well as recent judicial developments--provides an ample 
basis for a critical reexamination of these precedents.
---------------------------------------------------------------------------

    \83\ Release at 31; see also id. at 7-8.
    \84\ Release at 11 & n.26; see also id. at 6 & 23.
    \85\ Many of the abuses of Rule 102(e) stem from the all-
encompassing way in which the Commission has defined ``practice 
before'' us to include, at least at an earlier time, not only 
appearances before us and the staff, and filings made with us, but 
also office work by professionals directly related to the federal 
securities laws. See Robert J. Haft, Liability of Attorneys and 
Accountants for Securities Transactions para. 8.01[2], at 8-3 
(1997); see also Richard D. Hodgin, 49 S.E.C. 8, 10 (1979); SEC v. 
Ezrine, Litigation Release No. 6481, 1974 WL 13435 (S.E.C.) (Aug. 
15, 1974). In addition, partners of a disqualified professional may 
not permit the sanctioned person to participate in Commission 
matters, to participate in profits from their Commission business, 
or to hold him or her out as entitled to practice before the 
Commission. Haft, supra, at 8-3 to 8-4. Finally, partners and 
associates of a disqualified firm may not practice before the 
Commission as long as they remain associated with the firm, even if 
they joined the firm after the disqualification. Id. at 8-4.
    \86\ See Sheldon v. SEC, 45 F.3d 1515, 1518 (11th Cir. 1995); 
Davy, 792 F.2d at 1421; Touche Ross, 609 F.2d at 582.
---------------------------------------------------------------------------

    In Touche Ross, which was decided in 1979, the Commission 
successfully argued to the Second Circuit that Rule 102(e) was 
necessary to protect the integrity of its administrative processes.\87\ 
The Commission has consistently relied on the same rationale since 
then, which is repeated in today's release.\88\ Before the press of 
litigation arose, however, the Commission could be more candid. In a 
speech published in 1974 discussing ``spectacular recent failures'' 
such as the collapse of National Student Market Corporation, then-
Chairman Ray Garrett made the following statement:

    \87\ 609 F.2d at 579.
    \88\ Release at 7-8.
---------------------------------------------------------------------------

    We are not entirely happy with the means at our disposal to 
cause higher standards of professional conduct for investor 
protection. It is true that we can legislate rules governing the 
contents of financial statements filed with the Commission, but that 
won't insure a careful audit, and it certainly won't improve 
standards of professional conduct by lawyers. Our tools in this 
context, aside from informal comment and criticism, are enforcement 
weapons--suspension or disbarment from practicing before the 
Commission, under Rule 2(e) of our Rules of Practice, and an action 
for an injunction on the ground that the accountant or lawyer has 
participated in or aided and abetted a violation of the securities 
laws, including Rule 10b-5.\89\
---------------------------------------------------------------------------

    \89\ Ray Garrett, Jr., New Directions in Professional 
Responsibility, 29 Bus. Law. 7, 11 (1974) (emphasis added); see also 
id. at 9 (referring to stockholders of National Student Marketing 
losing ``in excess of $400 million in 3 months''). In Touche Ross, 
the Second Circuit purported to find support for the proposition 
that the Commission did not use Rule 102(e) as ``an additional 
weapon in the its enforcement arsenal'' in a Commission release that 
predated Chairman Garrett's remarks. See 609 F.2d at 579 (citing 
Securities Act Release No. 5088 at 1, 1970 SEC LEXIS 645 (Sept. 24, 
1970)). This release, however, supports the Touche Ross citation, if 
at all, only in the most general sense.

Former Chairman Garrett's remarks support the assertion of one 
commenter, a former Commission enforcement attorney who played a 
leading role in prosecuting Carter and other Rule 102(e) cases during 
the 1970's, that protection of the Commission's processes is merely a 
``convenient legal fiction'' or ``shibboleth [the Commission] used to 
win the Touche Ross[] case twenty years ago.'' \90\ This commenter also 
points out that, as a practical matter, the Commission's staff 
approaches Rule 102(e) proceedings in the same manner as other 
enforcement cases, such that charges under Rule 102(e) are just another 
enforcement alternative.\91\ This practical approach will often suit 
the convenience of potential respondents who may well prefer an 
administrative settlement of Rule 102(e) charges to other enforcement 
alternatives (e.g., a federal court injunctive action, in which the 
Commission would likely seek monetary penalties).\92\
---------------------------------------------------------------------------

    \90\ Richard E. Brodsky, P.A., CL 54, at 1 n.2 & 4. Mr. Brodsky 
candidly admits that he has ``represented numerous accounting firms 
in SEC investigations'' since leaving the Commission in 1981. Id. at 
1 n.2.
    \91\ Richard E. Brodsky, P.A., CL at 6.
    \92\ Id.; see also Judah Best, supra note 17, 36 Bus. Law. at 
1815 (from perspective of defense counsel, Rule 102(e) ``is a great 
settlement device''--``a means of avoiding the necessity of an 
injunction if you can bargain successfully for it'').
---------------------------------------------------------------------------

    The Commission's use of Rule 102(e) has not changed since 1974--it 
remains an ``enforcement weapon.'' Under usual procedures, the 
Commission's Division of Enforcement investigates cases, and, in the 
case of a financial fraud involving a public company, will routinely 
scrutinize the conduct of the responsible accountants.\93\ If the 
Division of Enforcement determines that the accountant's conduct is 
substandard, the Division of Enforcement will consult with the 
Commission's Office of the Chief Accountant, and then make an 
enforcement recommendation to the Commission.\94\ If the Commission 
authorizes the case as an administrative proceeding under Rule 102(e), 
the Division of Enforcement prosecutes it in the name of the Office of 
the Chief Accountant.\95\ As should be apparent from these procedures, 
notwithstanding surface appearances, Rule 102(e) is much more than a 
mere disciplinary rule.\96\ If Rule 102(e) were just a disciplinary 
rule, one would expect that the Commission's use of it would parallel 
other administrative agencies' use of their respective disciplinary 
rules--surely the Commission's processes need no greater protection 
than those of, for instance, the Federal Trade Commission or the 
Nuclear Regulatory Commission. But the opposite is true. Reflecting the 
enforcement nature of Rule 102(e), one academic has calculated that, 
over a 50-year period, the Commission has disbarred or suspended more 
lawyers than ``nearly all other federal agencies combined.'' \97\ Were 
accountants included in this tabulation, I am sure the numbers would 
demonstrate an even greater disparity.
---------------------------------------------------------------------------

    \93\ See Ferrara, supra note 17, 36 Bus. Law. at 1807-09.
    \94\ Id.; Coppolino, Note, supra note 17, 63 Fordham L. Rev. at 
2232.
    \95\ Id.: see SEC Announces Organizational Changes as to 
Accountants, Consumer Affairs, 1193 Daily Exec. Rep. (BNA) No. 236, 
at d-3 (Dec. 10, 1993). For lawyers, our Office of the General 
Counsel takes the place of the Division of Enforcement in 
recommending and prosecuting Rule 102(e) cases. Id.
    \96\ Many commenters have observed that the Commission's 
aggressive use of Rule 102(e) goes well beyond other agencies' use 
of comparable disciplinary rules (with the possible exception of the 
Office of Thrift Supervision, which intentionally modelled its 
disciplinary rule on Rule 102(e)). See, e.g., ABA, CL 81 at 3-4; see 
also Ted Schneyer, A Tale of Four Systems: Reflections on How Law 
Influences the ``Ethical Infrastructure'' of Law Firms, 39 S. Tex. 
L. Rev. 245, 263 (1998) (``Over the years, the Securities and 
Exchange Commission (SEC) and, more recently, the Office of Thrift 
Supervision (OTS) have asserted far-reaching authority to directly 
regulate lawyers who practice in their fields, much as judges 
regulate trial lawyers.''); Ted Schneyer, Professional Discipline 
for Law Firms?, 77 Cornell L. Rev. 1, 43-44 (1991) (under Rule 
102(e), SEC has been the ``most aggressive agency'' in disciplining 
lawyers). In addition, the Commission's use of Rule 102(e) goes well 
beyond standards used to enforce the disciplinary rules of most 
courts. See ABA CL 81, at 3-4; AICPA, CL 84 at 12.
    \97\ Emerson, supra note 17, 29 Am. Bus. L.J. at 178.
---------------------------------------------------------------------------

    These arguments that the Commission lacks the authority even to 
promulgate Rule 102(e) are not new. In fact, Commissioner Karmel, in a 
series of dissents starting almost 20 years ago, made many of the same 
points I make today.\98\ For instance, Commissioner Karmel began her 
best-known dissent as follows:

    \98\ Keating, 47 S.E.C. at 111 (Commissioner Karmel, 
dissenting); see also, e.g., Darrel L. Nielsen, 49 S.E.C. 50, 51 
(1980) (Commissioner Karmel, dissenting); Bernard J. Coven, 49 
S.E.C. 46, 47 (1979) (Commissioner Karmel, dissenting); Hodgin, 49 
S.E.C. at 11 (Commissioner Karmel, dissenting).
---------------------------------------------------------------------------

    This is another Rule 2(e) disciplinary proceeding which arises 
from the Commission's efforts to protect investors by articulating 
and enforcing professional responsibility standards for attorneys. 
The Commission's authority to promulgate Rule 2(e) is tenuous at 
best. Since the Commission's program is in aid of its prosecutorial 
function, rather than its rule making or adjudicatory functions, I 
view it as an invalid exercise of power * * *.\99\

    \99\ Keating, 47 S.E.C. at 109; see also id. at 111 (expressing 
disapproval of use of Rule 2(e) as ``a general enforcement tool to 
discipline attorneys''). Though Commission Karmel questioned most 
strongly the Commission's authority to regulate the conduct of 
attorneys, she questioned the Commission's authority to regulate the 
conduct of accountants as well. See id. at 111 & 115 n.31; see also 
Nielsen, 49 S.E.C. at 52-54 (Commissioner Karmel, dissenting).

---------------------------------------------------------------------------

[[Page 57180]]

    The force of Commissioner Karmel's arguments have increased, rather 
than diminished with time.\100\
---------------------------------------------------------------------------

    \100\ The academic commentary largely supports the view that 
Rule 102(e) is ``just part of the SEC's disciplinary enforcement 
arsenal.'' Emerson, supra note 17, 29 Am. Bus. L.J. at 167; see 
generally supra note 17.
---------------------------------------------------------------------------

    Starting with the Second Circuit's decision in Touche Ross,\101\ 
the few courts to consider these arguments have rejected them, but I 
think there is ample cause for reconsideration. As the Release 
repeatedly recognizes, the legitimacy of Rule 102(e) depends on it 
having a remedial purpose.\102\ A recent decision by the D.C. Circuit, 
Johnson v. SEC,\103\ however, and the Commission's response to it, 
place the characterization of Rule 102(e) as ``remedial'' in great 
doubt. In Johnson, the D.C. Circuit rejected the Commission's argument 
that sanctions imposed on a branch manager at a registered broker-
dealer, a censure and a six-month suspension, were ``remedial''; rather 
the Court determined that these sanctions fell within the definition of 
``penalty'' for purposes of the statute of limitations.\104\ Precisely 
these same sanctions, censure and suspension, are among the sanctions 
frequently imposed by the Commission in Rule 102(e) cases. Under the 
reasoning of Johnson, the punitive nature of Rule 102(e)'s sanctions 
could well give rise to questions about the Commission's ability to 
promulgate it. The D.C. Circuit decided Johnson after Checkosky I, but 
before Checkosky II.\105\ In Checkosky II, the D.C. Circuit determined 
that the Commission had failed to comply with the directions in 
Checkosky I that it clearly enunciate its standard for Rule 102(e), and 
thus had no need to determine whether, as a result of Johnson, the 
Commission still had the authority to promulgate Rule 102(e).
---------------------------------------------------------------------------

    \101\ 609 F.2d 570. In one of the many ironies surrounding Rule 
102(e), the opinion in Touche Ross was written by Judge Timbers. 
Before Judge Timbers' distinguished service as a federal judge, he 
served with distinction as the Commission's General Counsel in the 
mid-1950's. At that time, the General Counsel had supervisory 
responsibility for overseeing all the Commission's Rule 102(e) 
cases.
    \102\ Release at 7, 11 & n.26, 19 & 31.
    \103\ 87 F.3d 484 (D.C. Cir. 1996). At the time Johnson was 
decided, I disagreed with its reasoning, and supported the 
Commission's unsuccessful efforts to seek Supreme Court review. 
Regardless of my earlier disagreement with Johnson and my support of 
continuing efforts to raise this issue in other circuits, Johnson 
represents controlling law in the D.C. Circuit and will almost 
certainly be a factor the next time the D.C. Circuit reviews Rule 
102(e).
    \104\ 87 F.3d at 485-87 (construing 28 U.S.C. 2462).
    \105\ Because Johnson came after Checkosky I, I regard the 
statements of Judges Silberman and Randolph supporting the 
Commission's ability to promulgate Rule 102(e) as less than 
authoritative. See 23 F.3d at 455 (Silberman, J.) & 472 (Randolph, 
J.). Because there was no opinion of the Court in Checkosky I, the 
D.C. Circuit probably need not invoke en banc procedures in its next 
review of Rule 102(e) to determine whether to follow the Second 
Circuit's decision in Touche Ross. Any panel of the D.C. Circuit 
would have the power to decide to follow or not to follow Touche 
Ross.
---------------------------------------------------------------------------

    Subsequent action by the Commission indicate its own recognition 
that this argument may be well-founded. In Angelo P. Danna, CPA, two 
accountants filed a motion to dismiss a Rule 102(e) proceeding as one 
seeking a penalty and thus time-barred under Johnson.\106\ The Division 
of Enforcement failed to object, and the Commission dismissed the 
proceeding.\107\ Likewise, in George Craig Stayner, CPA, the Commission 
dismissed a Rule 102(e) case against an accountant who had raised the 
Johnson issue, this time over the objection of the Office of the Chief 
Accountant.\108\ In several analogous disciplinary cases not involving 
Rule 102(e), the Commission has ordered dismissals, without objections 
from the staff, in response to similar arguments relying on 
Johnson.\109\ Given the time and resources the Commission devoted to 
Danna and Stayner, one would have thought the Commission would have 
declined to dismiss these cases if it had any confidence in its chances 
on the ``punitive''/``remedial'' question in the D.C. Circuit.
---------------------------------------------------------------------------

    \106\ Exchange Act Release No. 38499, 1997 WL 197555 (S.E.C.) 
(April 14, 1997). These respondents had earlier sought to enjoin the 
Commission in federal court from commencing the Rule 102(e) 
proceedings; in an unpublished decision (relied on in the Release at 
18 & 29), the district court held that the Commission's Rule 102(e) 
authority is not limited to instances of intentional misconduct or 
bad faith. See Danna v. SEC, 1994 WL 315877 (N.D. Cal. Feb. 8, 
1994).
    \107\ 1997 WL 197555 (S.E.C.).
    \108\ Exchange Act Release No. 39994, 1998 SEC LEXIS 956 (May 
14, 1998).
    \109\ See, e.g., Paul C. Kettler, Exchange Act Release No. 
40011, 1998 SEC LEXIS 986 (May 20, 1998); Richard M. Kulak, Exchange 
Act Release No. 38657, 1997 SEC LEXIS 1113 (May 20, 1997).
---------------------------------------------------------------------------

    In my view, the purpose of Rule 102(e) is not to protect the 
Commission's administrative processes, but rather to enforce compliance 
with the federal securities laws. In addition, under controlling law in 
the D.C. Circuit, Rule 102(e) is punitive, not remedial. As a result, 
the Commission lacks the authority even to promulgate Rule 102(e).

B. The Commission Lacks the Authority To Adopt a Negligence Standard

    Even assuming the Commission could validly promulgate Rule 102(e), 
it lacks the authority to adopt a negligence standard. In my view, this 
conclusion is compelled by the D.C. Circuit's decisions in Checkosky I 
and Checkosky II.\110\ Others at the Commission question my 
interpretation of both Checkosky cases, but I note that this same urge 
to construe an adverse decision as narrowly as possible (sometimes even 
more narrowly than possible) is precisely what so enraged the D.C. 
Circuit in Checkosky II.\111\
---------------------------------------------------------------------------

    \110\ See supra Section II.
    \111\ A respected securities scholar, Dean Joel Seligman of the 
University of Arizona College of Law, submitted a comment letter 
opining that, although ``there is some uncertainty'' because of the 
Checkosky decisions, the Commission has the authority under the 
federal securities laws to adopt a negligence standard for Rule 
102(e). See CL 53 at 2. Dean Seligman qualified his endorsement in 
other important ways--even he expressed concerns about the clarity 
of the June proposal. See CL 53 at 3. Dean Seligman's opinion is 
contrary to the clear weight of academic commentary. See, e.g., 
Downing & Miller, supra note 17, 54 Notre Dame Law. at 775-81; 
Maxey, supra note 12, 22 Del. J. Corp. L. at 563-64; Flagel, Note, 
supra note 17, 20 Dayton L. Rev. at 1095-98; see also supra note 17. 
In addition, most other commenters share my view that the Checkosky 
opinions appear to preclude the Commission from adopting a 
negligence standard. See ABA, CL 81 at 3; Robert K. Elliott, 
Partner, KPMG Peat Marwick LLP (``KPMG Peat Marwick''), CL 82 at 2-
3; AICPA, CL 84 at 4-5 & 10-15; see also, e.g., Don Hummel, 
Administrative Director, Department of Commerce and Insurance, 
Tennessee State Board of Accountancy, CL 12; Richard Y. Roberts, CL 
18.
---------------------------------------------------------------------------

    I must confess that I remain somewhat mystified by the begrudging 
attitude towards Checkosky that is prevalent at the Commission. After 
two of the worst defeats in the Commission's 60-plus year history, we 
should not adopt merely the absolute minimum necessary to pass muster 
in the D.C. Circuit. Rather, we should strive toward caution and 
conservatism, and give ourselves an ample margin for error. The 
Standard is not cautious; it is not conservative. Instead, the 
Commission has again reverted to a ``push the envelope'' strategy, and 
thrown down the gauntlet to the D.C. Circuit.
    Editorializing aside, I believe that the Commission lacks the 
authority to adopt a negligence standard under Rule 102(e). No 
appellate court has approved the Commission's adoption of a negligence 
standard, and I fully concur with the ABA's statement that ``the 
prognosis for appellate court affirmance of * * * a [negligence-based] 
standard is very poor.'' \112\ Of course, the Release denies that what 
the Commission has adopted is a ``simple'' or ``mere'' negligence 
standard.\113\ But the Proposing Release contained similar

[[Page 57181]]

unconvincing attempts to narrow what seemingly was an all-encompassing 
standard.\114\ Interested parties submitted over 150 comment letters, 
more than half (by my estimate) expressing skepticism or worse as to 
whether the standard in the Proposing Release truly limited the 
Commission's discretion to bring Rule 102(e) cases for simple 
negligence. Though insisting that it has the authority to adopt a 
``simple'' or ``mere'' negligence standard, the Commission now purports 
to adopt a higher standard.\115\ I think that the Standard will not 
limit the Commission's discretion to bring cases for simple negligence. 
Moreover, as I discuss in the next section, the revisions to the 
Proposing Release's standard only add to the lack of clarity 
surrounding this issue.
---------------------------------------------------------------------------

    \112\ ABA, CL 81 at 3. Cf. Checkosky I, 23 F.3d at 456 
(Silberman, J.) (courts of appeals have not ``squarely addressed'' 
question of Commission's authority to adopt a negligence standard 
under Rule 102(e)). Although the Eleventh Circuit's subsequent 
opinion in Sheldon, 45 F.3d at 1518, discussed generally the 
Commission's authority to promulgate Rule 102(e), it did not address 
the negligence question.
    \113\ Release at 30.
    \114\ Proposing Release, 1998 WL 311988 (S.E.C.), at *4.
    \115\ Release at 30.
---------------------------------------------------------------------------

    As an initial matter, it is important to recognize that today's 
release actually expands the Commission's Rule 102(e) jurisdiction 
beyond that encompassed by the Proposing Release. The single negligent 
act provision in the Proposing Release contained a requirement that the 
act be tied to ``making a document prepared pursuant to the federal 
securities laws materially misleading.'' \116\ The single negligent act 
provision in the Standard omits this requirement, thereby increasing 
substantially the potential reach of Rule 102(e).\117\
---------------------------------------------------------------------------

    \116\ Proposing Release, 1998 WL 311988 (S.E.C.), at *3.
    \117\ See supra note 85 and accompanying text.
---------------------------------------------------------------------------

    The Standard does contain two elements which form the basis for the 
Commission's claim that it adopts ``an intermediate standard, higher 
than ordinary negligence but lower than the traditional definition of 
[Rule 10b-5] recklessness.'' \118\ These elements are that the alleged 
misconduct: (1) Must be ``highly unreasonable,'' not merely 
``unreasonable,'' as in the Proposing Release; and (2) must occur under 
``circumstances in which an accountant knows, or should know, that 
heightened scrutiny is warranted.'' \119\ On close examination, these 
elements present only illusory limits on the Commission's discretion to 
bring charges of ``improper professional conduct'' based on a single 
act of negligence.
---------------------------------------------------------------------------

    \118\ Release at 18.
    \119\ Release at 14.
---------------------------------------------------------------------------

    Unlike ``highly unreasonable conduct,'' the Proposing Release 
discussed the concept of ``heightened scrutiny,'' and, accordingly, 
interested parties had the opportunity to explain its drawbacks. The 
AICPA objected to any attempt by the Commission to

use Rule 102(e) proceedings to determine in the first instance the 
circumstances under which particular items of financial statements 
require ``heightened scrutiny.'' In our view, auditors should 
determine which items require increased scrutiny according to 
existing professional guidance, not because they fear the Commission 
will, in hindsight, so conclude. Determinations announced 
retrospectively by an Administrative Law Judge or the Commission 
would make Rule 102(e) a vehicle for improper back-door regulation 
through the adjudicatory announcement of standards.\120\
---------------------------------------------------------------------------

    \120\ AICPA, CL 84 at 14 (footnotes omitted).

I fully endorse these views.
    Furthermore, I think the Commission's use of ``heightened 
scrutiny'' is merely a form of materiality that will have no practical 
effect on limiting the Commission's ability to bring cases for simple 
negligence. One would think that the Commission would have limited 
interest in bringing Rule 102(e) cases for alleged misconduct that 
involved only immaterial matters, but the Release tells us 
otherwise.\121\ The Release asserts that the Commission need not show 
either actual harm or materiality under Rule 102(e) because:

    \121\ Release at 24-25.
---------------------------------------------------------------------------

    An auditor who fails to audit properly under GAAS--whether 
recklessly or highly unreasonably--should not be shielded because 
the audited financial statements fortuitously turn out to be 
accurate or not materially misleading.\122\

    \122\ Release at 25.
---------------------------------------------------------------------------

I am troubled by this statement. The ``heightened scrutiny'' element is 
based in considerations of materiality, yet the Release disclaims any 
need for the Commission to prove materiality. This is but one of the 
many contradictions and ambiguities raised by the Standard. As in 
Checkosky, the Commission refuses to recognize any meaningful 
limitations on its discretion to bring cases under Rule 102(e).
    Likewise, the other added requirement--that the Commission prove 
that the single negligent act was ``highly unreasonable,'' rather than 
simply ``unreasonable''--also fails to place any significant 
limitations on the Commission's discretion under Rule 102(e). In my 
view, this distinction amounts to no more than legal hair-splitting. It 
seems that ``highly unreasonable conduct'' was chosen precisely for its 
lack of content: it is an empty vessel that gives virtually no guidance 
to the accounting profession or reviewing courts and into which the 
Commission can pour whatever content it deems fit, contrary to the 
dictates of Checkosky.\123\
---------------------------------------------------------------------------

    \123\ See Checkosky I, 23 F.3d at 462 (Silberman, J.); see also 
Checkosky II, 139 F.3d at 224-25.
---------------------------------------------------------------------------

    One person's ``unreasonable'' act might well be another person's 
``highly unreasonable'' act. Since the Commission has a well-deserved 
reputation for aggressiveness in its interpretation of Rule 102(e), it 
seems likely that what it considers ``highly unreasonable'' may not 
appear to others even to be ``unreasonable'' at all.\124\ I cannot 
imagine a single case that the Commission would have wanted to bring 
under the standard in the Proposing Release that it could not also 
bring under the Standard. The revisions from the standard in the 
Proposing Release amount to mere window dressing, having more to do 
with assisting the Commission's litigation posture than with giving 
proper deference to the good faith judgment calls of accountants.
---------------------------------------------------------------------------

    \124\ See Kivitz v. SEC, 475 F.2d at 962 (D.C. Circuit reversed 
Commission's finding of liability in Rule 102(e) disbarment case for 
lack of substantial evidence; declining to give Commission any 
deference on issues of alleged professional misconduct); see also, 
e.g., Checkosky I, 23 F.3d at 482 n.17 (Randolph, J.) (expressing 
``serious doubt'' whether the evidence supported the Commission's 
recklessness finding; noting contradiction between Commission's 
opinion and Commission's position at oral argument).
---------------------------------------------------------------------------

    In attempting to justify the standard, the Commission treads on 
thin ice. The Release asserts that: ``The Commission believes that a 
negligent auditor can do just as much harm to the Commission's 
processes as one who acts with an improper motive.'' \125\ This is the 
very same Commission argument two judges of the D.C. Circuit rejected 
in Checkosky I. Judge Randolph recognized that the Commission had made 
this same argument in Hochfelder as support for not requiring scienter 
under Rule 10b-5, and the Supreme Court had there rejected `` `this 
effect-oriented approach' '' as one that would logically result in 
absolute liability whenever investors suffered harm.\126\ Similarly, 
Judge Silberman also questioned this argument, observing that the 
Commission's no-fault

    \125\ Release at 17; see also id. at 10 & 11.
    \126\ 23 F.3d at 483 (quoting Hochfelder, 425 U.S. at 198).
---------------------------------------------------------------------------

language, tellingly, suggests that the Commission's reasons for 
considering an auditor's negligence to be `improper professional 
conduct' ha[ve] more to do with protecting the public than the 
Commission's administrative processes.\127\

    \127\ 23 F.3d at 459 & n.7. Although toned down, the Release 
still contains multiple references to investor protection as a valid 
rationale for Rule 102(e) proceedings which seem questionable in 
light of Judge Silberman's observation. See Release at 9 
(``Investors have come to rely on the accuracy of the financial 
statements of public companies when making investment decisions.''); 
see also id. at 5, 9-10 & 22.

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[[Page 57182]]

Notwithstanding the harsh scolding received in Checkosky II, the 
Commission seems bound and determined to repeat its past mistakes.
    The Standard exceeds the Commission's authority in several ways. It 
improperly gives the Commission de facto substantive regulatory 
authority over the accounting profession, and it arrogates to the 
Commission authority to enforce the securities laws that is reserved to 
the federal courts. Accountants, like attorneys, are members of 
``ancient professions,'' regulated according to rigorous ethical rules 
enforced by professional societies and state licensing boards. I simply 
do not believe that we should recast negligent violations of an 
accounting standard as improper professional conduct under the 
Commission's Rules of Practice. That is not an appropriate role for the 
Commission. Difficult ethical and professional responsibility concerns 
are generally matters most appropriately dealt with by professional 
organizations or, in certain cases, malpractice litigation. Nor do I 
believe that mere misjudgments or negligence establishes either 
professional incompetence warranting Commission disciplinary action or 
the likelihood of future danger to the Commission's processes.
    The comment letters overwhelmingly echo these thoughts.\128\ One 
commenter asserted that the Commission is improperly expanding its 
authority over matters properly left to the states and the AICPA:
---------------------------------------------------------------------------

    \128\ E.g., Peter D. Rothman, Volt Information Sciences, Inc., 
CL 28; John Sommerer, CPA, CL 46; Richard Dillon, CL 86; Robert A. 
Boyd, CPA, CL 126; Robert J. Sonnelitter, Jr., Director, Accounting 
and Auditing, Reminick, Aarons & Co., LLP, CL 128; Frank H. Brod, 
CPA, CL 137; Bull and Associates, Austin, Texas, CL 143; Kyle E. 
Carrick, CPA, Senior Financial Analyst, International Accounting, 
The SABRE Group (``SABRE''), CL 144.

    The Commission's sole legitimate goal with respect to Rule 
102(e), absent any express statutory authority to punish 
professionals for misconduct, is to regulate the conduct of practice 
before it, not to serve as the ``first line of defense'' against 
---------------------------------------------------------------------------
violations of professionals standards more generally.\129\

    \129\ Wayne A. Kolins, National Director of Accounting and 
Auditing, BDO Seidman, LLP (``BDO Seidman''), CL 80 at 3; see AICPA, 
CL 84 at 5.
---------------------------------------------------------------------------

Another commenter remarked that adoption of a negligence standard would 
``constitute an illegitimate expansion of the Commission's regulatory 
powers.'' \130\
---------------------------------------------------------------------------

    \130\ Steven A. Templeton, Templeton & Company, P.A., CPAs, CL 
24.
---------------------------------------------------------------------------

    Today's release claims that: ``The Commission does not seek to use 
Rule 102(e)(1)(ii) to establish new standards for the accounting 
profession.'' \131\ I disagree. The Commission is being too modest in 
protesting that it does not set substantive ethical standards.\132\ In 
the past--pre-Checkosky I, of course, the Commission boasted about its 
instrumental uses of Rule 102(e) litigation to set ethical standards 
for both lawyers and accountants. In Carter, the Commission reversed 
sanctions an ALJ had imposed on two lawyers because of the recognition 
that the Commission itself had not ``firmly and unambiguously 
established'' the relevant ``ethical and professional 
responsibilities.'' \133\ The length of the Commission's 43-page 
opinion in Carter largely resulted from the Commission's attempts to 
articulate the relevant Rule 102(e) standards in exhaustive 
detail.\134\
---------------------------------------------------------------------------

    \131\ Release at 13; see also id. at 21.
    \132\ See, e.g., Susan P. Koniak, When Courts Refuse to Frame 
the Law and Others Frame It to Their Will, 66 S. Cal. L. Rev. 1075, 
1087 n.50 (1993) (``The SEC has used rule 2(e) proceedings to 
announce standards of conduct applicable to the legal 
profession.'').
    \133\ 47 S.E.C. at 508 (``We also recognize that the Commission 
has never articulated or endorsed [the relevant] standards.'').
    \134\ 47 S.E.C. at 508 (``[T]he Commission is hereby giving 
notice of its interpretation of `unethical or improper professional 
conduct' as that term is used in Rule 2(e)(1)(ii).'').
---------------------------------------------------------------------------

    The Commission has also used Rule 102(e), at the very least, to 
explain the application of professional standards for accountants, as 
reflected in a 1991 article co-written by a former Commission General 
Counsel and the then-Assistant General Counsel who supervised 
litigation of all Rule 2(e) cases, which stated as fact that:

the Commission frequently uses Rule 2(e) proceedings as a forum for 
explaining its views concerning the professional standards 
applicable to accountants. Indeed, the Commission's guidance to 
accountants on particular facets of the audit function is often more 
extensive than that issued by the profession's standard-setting 
bodies.\135\

    \135\ Goelzer & Wyderko, supra note 11, 85 Nw. U. L. Rev. at 666 
(emphasis added). To the same effect, this article also asserted:
    Rule 2(e) affords the Commission a vehicle to engage, to a 
limited degree, in professional standard-setting. Through its 
opinions and orders in these proceedings, the Commission articulates 
what it deems to be improper or unprofessional conduct in particular 
factual situations. For example, because of the concentration during 
the last decade of the Commission's enforcement program on 
``financial fraud,'' the use of Rule 2(e) against auditors of public 
companies has increased. This, in turn, has created an important 
body of Commission case law on auditor's responsibilities * * *.
    Id. at 653.
---------------------------------------------------------------------------

    These observations also seem to describe accurately the likely 
effects of the Commission's present rulemaking. Many commenters pointed 
out that the standard in the Proposing Release went well beyond those 
promulgated by most state accountancy boards.\136\ Even assuming that 
the revisions reflected in the Standard have substance, which I doubt, 
most state standards contain a ``good faith'' element that the Release 
expressly rejects.\137\ Therefore, the amendment has the potential to 
cause a fundamental change in the way accountants approach their 
duties. As occurred during the National Student Marketing and Arthur 
Young era, I think accountants may well be forcibly conscripted into 
following the staff's views because of well-grounded fears that 
otherwise they may face Rule 102(e) sanctions.\138\
---------------------------------------------------------------------------

    \136\ See AICPA, CL 84, at 25-26; see generally, e.g., Paul 
Seitz (attached to comment letter of Dennis Paul Spackman, CPA, CL 
15); John Sommerer, CPA, CL 46; Robert Sonnelitter, CL 128: Frank H. 
Brod, CPA, CL 137.
    \137\ Id.; Release at 32-33.
    \138\ See, e.g., Downing & Miller, supra note 17, 54 Notre Dame 
Law. at 786 (suggesting that objective for Rule 102(e) might be to 
``subjugate the accounting profession to the Commission's day-to-day 
control''); Francis M. Wheat, SEC v. Bar--``Fear'' is the Name of 
the Game, N.Y*L.J., Aug. 16, 1978, at 1, col. 2.
---------------------------------------------------------------------------

IV. The Proposed Standard Is Unclear

    One of the few things regarding Rule 102(e) on which my colleagues 
and I agree is that, as a result of the Checkosky opinions, the 
Commission has the obligation to set forth clear standards.\139\ In my 
view, the most important part of the Standard--that rendering an 
accountant's single act of negligence actionable under Rule 102(e)--
fails to comply with the directions of the D.C. Circuit in Checkosky. I 
think today's release introduces new flaws that were not contained in 
the Proposing Release. In June, I severely criticized the earlier 
standard on the jurisdictional and policy grounds, but I did not claim 
that it was unclear.\140\ On the contrary, as I interpreted it, the 
Commission sought to adopt a simple negligence standard. The Proposing 
Release went to some pains to deny that the standard it contained 
amounted to mere negligence, but I was not convinced. In fact, the 
ambiguity and lack of clarity in the Proposing Release largely resulted 
from the Commission's unpersuasive attempts to explain why the earlier 
standard did not amount to simple negligence.
---------------------------------------------------------------------------

    \139\ See Release at 2.
    \140\ Proposing Release, 1998 WL 311988 (S.E.C.), at *9 
(Commissioner Johnson, dissenting).

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[[Page 57183]]

    Now, in response to a tidal wave of comment letters complaining 
about the Commission's lack of authority to adopt a negligence 
standard, the Commission purports to adopt ``an intermediate standard, 
higher than ordinary negligence but lower than the traditional 
definition of [Rule 10b-5] recklessness.'' \141\ Even if this 
description were accurate--and I do not agree that it is--it only 
serves to emphasize the lack of clarity in the Standard.
---------------------------------------------------------------------------

    \141\ Release at 18.
---------------------------------------------------------------------------

    At first blush, one might think that the Standard is based in 
recklessness. After all, the term ``highly unreasonable'' is part of 
traditional definitions of ``recklessness.''\142\ However, the Release 
correctly insists that the Standard is not a recklessness 
standard.\143\ If, as the Release claims, the Standard is an 
intermediate standard, the next logical choice would be ``gross 
negligence.'' Again, however, the Release is at some pains to disclaim 
that its standard amounts to gross negligence. In a footnote, the 
Release explains that ``[t]he Commission is not adopting a `gross 
negligence' standard because courts have not interpreted the term 
uniformly.'' \144\ I disagree. I think that the majority view tends to 
equate ``gross negligence'' with ``recklessness,'' as stated by the 
leading American torts authority, Prosser and Keeton:

    \142\ See Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 
1045 (7th Cir. 1977) (defining recklessness as `` `highly 
unreasonable' '' conduct involving `` `an extreme departure from the 
standards of ordinary care' ''); See also, e.g., Mansbach v. 
Prescott, Ball & Turben, 598 F.2d 1017, 1025 (6th Cir. 1979) 
(following Sundstrand); W. Page Keeton et al., Prosser and Keeton on 
The Law of Torts 214 (5th ed. 1984).
    \143\ Release at 18-19 & n.42. The Standard omits the second 
part of traditional formulations of recklessness that requires ``an 
extreme departure of ordinary care.'' See Sundstrand, 553 F.2d at 
1045; Keeton, supra note 142, at 214. One comment letter proposed 
the addition of an ``extreme departure'' element. See J. Michael 
Cook, Chairman and Chief Executive Officer, and Philip R. Rotner, 
General Counsel, Deloitte and Touche LLP, CL 77 at 5-6.
    \144\ Release at 22 n.49.
---------------------------------------------------------------------------

``reckless'' conduct tends to take on the aspect of highly 
unreasonable conduct, involving an extreme departure from the 
standards of ordinary care, in a situation where a high degree of 
danger is apparent. As a result there is often no clear distinction 
at all between such conduct [i.e., ``recklessness''] and ``gross'' 
negligence, and the two have tended to merge and take on the same 
meaning, of an aggravated form of negligence * * * . It is at least 
clear, however, that such aggravated negligence must be more than 
any mere mistake * * *, and more than mere thoughtlessness or 
inadvertence, or simple inattention, * * * or even of an intentional 
omission to perform a statutory duty.\145\
---------------------------------------------------------------------------

    \145\ Keeton, supra note 142, at 214 (footnotes citing cases 
omitted).

In any event, ``gross negligence'' itself is a highly unclear term that 
Prosser and Keeton, among others, disfavor.\146\ Thus, the Commission 
has rejected as unclear a ``gross negligence'' standard in favor of a 
standard that is even more unclear (and unlike ``gross negligence'' and 
``recklessness'' has no currency among courts, lawyers or accountants).
---------------------------------------------------------------------------

    \146\ Keeton, supra note 142, at 211 (quoting common law judge 
for proposition that ```gross' negligence is merely the same thing 
as ordinary negligence, `with the addition * * * of a vituperative 
epithet''').
---------------------------------------------------------------------------

    One thing is clear, however, and that is the Commission intends its 
new Rule 102(e) standard to reach conduct that would not amount to 
``recklessness'' or ``gross negligence'' under the Prosser and Keeton 
definition.\147\ If the Commission's standard is not ``recklessness'' 
or ``gross negligence,'' as those terms have been traditionally 
defined, well then what is it? The logical answer would seem to be 
simple negligence, but the Release expressly disclaims that alternative 
as well.\148\ As stated in the preceding section, however, it seems 
that the Standard will amount to simple negligence, though the Release 
does contain disguised hints of an intent to apply a strict liability 
standard in some areas as well.\149\
---------------------------------------------------------------------------

    \147\ e.g., Release at 18-26.
    \148\ Release at 30.
    \149\ See Release at 13 n.31, 14 n.32 & 23.
---------------------------------------------------------------------------

    The Release's equivocal, simultaneous embrace and rejection of 
recklessness, gross negligence, negligence and strict liability seem 
familiar, with good reason. The Commission employed exactly the same 
strategy in Checkosky--the Release represents yet another ``tour de 
force'' by the Commission.\150\ Again, the Commission has the best of 
intentions in its efforts to improve accounting standards, but, as the 
D.C. Circuit has told us, good intentions alone cannot make up for 
deficiencies in ``[e]lementary administrative law norms of fair notice 
and reasoned decisionmaking.'' \151\
---------------------------------------------------------------------------

    \150\ Checkosky II, 139 F.3d at 223.
    \151\ Checkosky II, 139 F.3d at 224.
---------------------------------------------------------------------------

    With the Standard, the Commission attempts to have it both ways. 
Because the Checkosky decisions raised questions about its authority, 
the Commission purports to adopt something more than the simple 
negligence standard contained in the Proposing Release (which the 
Proposing Release denied was a simple negligence standard). In 
attempting to finesse the issue of its authority, however, the 
Commission has sacrificed clarity. With due recognition to the 
dedication, hard work and long hours put in by the Commission's staff, 
the Standard and the Release are convoluted and incomprehensible--they 
have been written by committee and point in varying and conflicting 
directions. The Standard does not meet the requirements of due process 
and will not give accountants adequate guidance as to what the 
Commission may allege, in hindsight, to have been ``improper 
professional conduct.''

V. The Proposed Standard Is Not in the Public Interest

    As explained above, the Commission lacks the legal authority to 
adopt the Standard and the standard is itself unclear, contrary to what 
was demanded of the Commission in the Checkosky opinions. Even apart 
from these fatal flaws, strong public policy considerations also call 
for rejection of the Standard: (a) The Standard is arbitrary and 
capricious in failing to explain why accountants should be singled out 
for discriminatory treatment; (b) the Standard will interfere with the 
ability and willingness of accountants to exercise independent 
professional judgment; (c) the costs of the Standard will exceed its 
benefits; and (d) the Standard will unfairly disadvantage small 
accounting firms. s

A. The Standard Is Arbitrary and Capricious in Singling Out Accountants 
for Discriminatory Treatment

    By my rough count, about half of the comment letters specifically 
complained that the standard in the Proposing Release discriminated 
against accountants.\152\ The basis for this assertion is simple and 
compelling--the Commission applies a scienter standard in Rule 102(e) 
proceedings against lawyers, and the standard in the Proposing Release 
would have allowed the Commission, without adequate justification, to 
impose sanctions on accountants for much less egregious conduct.\153\ 
Several commenters also correctly pointed out that the standard in the 
Proposing Release would allow

[[Page 57184]]

the Commission to bar accountants from SEC practice for much less 
serious misdeeds than required to bar members of corporate management 
(who almost without exception have the greatest culpability for 
financial frauds in which accountants have secondary liability) from 
serving as officers and directors of public companies.\154\ The 
Standard fails to remedy these disparities.
---------------------------------------------------------------------------

    \152\ See PricewaterhouseCoopers LLP, CL 116; see also, e.g., 
Peter D. Rothman, Volt Information Sciences, Inc., CL 28; Eric 
Tanquist, CL 32; Daniel S. Kuerner, CPA, CL 33; James I. Linkous, 
CPA, CL 34; Raymond F. Marin, Hixson, Marin, Powell & De Sanctis, 
P.A., CPAs, CL 45; AICPA, CL 84; Nancy L. Ryder, CL 85; Dominick A. 
Bellino, CPA, CL 87; Michael D. Castleberry, CPA, CL 90; Wayne 
Scroggins, CL 89; Public Company Practice Committee, Colorado 
Society of CPAs, CL 99; Myron J. Banwart, CPA, CL 125.
    \153\ E.g., AICPA, CL 84 at 19 (citing Carter, 47 S.E.C. at 
511); see also KPMG Peat Marwick, CL 82 at 2 & 6-8.
    \154\ See AICPA, CL 84 at 20 (referring to showing Commission 
must make to obtain an officer and director bar under Section 20(e) 
of the Securities Act or Section 21(d)(2) of the Exchange Act); 
Arthur Andersen, CL 98 at 8-9 & n.21. In addition, the standard in 
the Proposing Release and the Standard disadvantage accountants as 
compared with similarly situated broker-dealers, for whom the 
Commission has direct statutory authority to discipline. See Arthur 
Andersen, CL 98 at 9 & n.22 (citing Section 15(b)(6) of the Exchange 
Act).
---------------------------------------------------------------------------

    This point is not obscure. To the contrary, Judge Randolph made it 
a centerpiece of his demonstration that the Commission had acted 
arbitrarily and capriciously in Checkosky I.\155\ Relying on Carter, 
``the Commission's most comprehensive discussion of the history, 
purpose and operation of Rule 2(e),'' Judge Randolph held that the 
Commission was required to apply a scienter standard in all Rule 102(e) 
proceedings and that the Commission had therefore erred in failing to 
apply a scienter standard in Checkosky.\156\
---------------------------------------------------------------------------

    \155\ 23 F.3d at 483-87.
    \156\ Id.
---------------------------------------------------------------------------

    Accountants and lawyers do have different duties and obligations. 
As a general matter, lawyers must zealously advocate the interests of 
their private clients, while accountants have an overriding duty to the 
investing public. As a consequence of accountants' public obligations--
the ``P'' in CPA--they have a statutory duty, under certain 
circumstances, to report a client's past fraudulent activities.\157\ As 
was Judge Randolph, I am aware of these differences, but fail to 
understand why they should make a difference for purposes of Rule 
102(e).\158\ As several commenters perceptively pointed out, Rule 
102(e) proceedings for ``improper professional conduct'' are 
necessarily based on the failure to follow applicable professional 
standards.\159\ Because applicable standards already incorporate and 
distinguish between the differing duties and obligations of various 
professions, there is no logical basis for the Commission to apply 
different mental state requirements under Rule 102(e).\160\
---------------------------------------------------------------------------

    \157\ See Checkosky I, 23 F.3d at 485-86; see also Exchange Act 
10A(b)(3), 15 U.S.C. 78j-1(b)(3) (requiring auditors to report 
illegalities to board of directors, and resign and notify the 
Commission if the board fails to notify the Commission).
    \158\ 23 F.3d at 486-87.
    \159\ BDO Seidman, CL 80 at 5-6 & n.6; AICPA, CL 84 at 22-23.
    \160\ Id.
---------------------------------------------------------------------------

    In any event, regardless of whether the Commission could justify 
applying different mental state requirements to lawyers and 
accountants--and I do not totally foreclose this possibility--it has 
not made even an attempt to do so.\161\ Other than to state the 
obvious, i.e., ``this release does not address the conduct of 
lawyers,'' the Release fails to discuss why the Commission should apply 
a less forgiving standard to accountants than to lawyers and others who 
also play an equally crucial role in the ``financial reporting 
process.''\162\ Indeed, the Release fails even to cite, much less to 
discuss Carter.
---------------------------------------------------------------------------

    \161\ The Commission has limited indirect statutory authority to 
regulate the conduct of accountants that it lacks for lawyers. See 
ABA, CL 81 at 11 & n.6 (citing Items 25 and 26 of Schedule A to the 
Securities Act, and Section 10A and Section 12(b)(1)(J) and (K) of 
the Exchange Act); see also Securities Act Section 19(a), 15 U.S.C. 
77s(a) (Commission has authority, among other things, to define 
accounting terms and to prescribe accounting methods used in 
preparation of financial forms filed with the Commission).
    \162\ Release at 25-26.
---------------------------------------------------------------------------

    In Checkosky I--on this very issue of the Commission's differential 
treatment of accountants and lawyers under Rule 102(e)--Judge Randolph 
noted that ``[o]ne of the abiding principles of administrative law is 
that when agencies refuse to treat like cases alike, they act 
arbitrarily, in violation of the Administrative Procedure Act, 5 U.S.C. 
Sec. 706(2)(A).'' \163\ Judge Randolph elaborated that should factual 
differences ``lead to variations in the interpretation and application 
of [an agency's] rules,'' the agency then becomes obligated to provide 
a ``reasoned explanation'' of why the differences should matter.\164\ 
Although Judge Silberman choose to rely primarily on the lack of 
clarity in the Commission's first Checkosky opinion, he too noted that 
the Commission had failed to give an adequate explanation for its 
differential treatment of lawyers and accountants under Rule 
102(e).\165\ The Commission now repeats the same arbitrary and 
capricious error it committed in Checkosky.\166\
---------------------------------------------------------------------------

    \163\ 23 F.3d at 483 (citations omitted).
    \164\ 23 F.3d at 483-84.
    \165\ 23 F.3d at 458-59. The third judge in Checkosky I, 
District Judge Reynolds accepted the Commission's arguments that 
Carter did not apply to the ``improper professional conduct'' 
provision of Rule 102(e) and that, in any event, the Commission had 
a rational reason for not following Carter based on the ``overriding 
duty'' of accountants/auditors to the investing public. 23 F.3d at 
494-95.
    \166\ Lest I be thought obtuse, I will point out my awareness 
that this omission is entirely deliberate. Based on discussion at 
the Commission's open meetings on June 12, 1998 and September 23, 
1998, some at the Commission intend to ramp up our Rule 102(e) 
enforcement program as to lawyers, a prospect I view with alarm. 
Because, as always, the Commission wishes to leave its future 
options open regarding Rule 102(e), the Release intentionally 
glosses over this point.
---------------------------------------------------------------------------

B. The Standard Will Interfere With Accountants' Exercise of Their 
Independent Professional Judgment

    Our system of securities regulation is based on disclosure. To 
ensure that Commission filings and other statements made to the 
investing public are truthful and accurate, we have to rely in large 
part on the work of talented, well-trained professionals. Accordingly, 
I fully agree with former Chairman Williams' statement that we would be 
unable to administer effectively the securities laws if those 
``involved in the capital raising process were not routinely served by 
professionals of the highest integrity and competence, well-versed in 
the requirements of the statutory scheme Congress has created.''\167\ 
On the other hand, I also believe that the Commission has a limited 
mandate under Rule 102(e) for determining who may ``practice before'' 
us, and that we must exercise a high degree of self-restraint in this 
area.
---------------------------------------------------------------------------

    \167\ Keating, 47 S.E.C at 120 (Chairman Williams, concurring).
---------------------------------------------------------------------------

    As to accountants, the very nature of their responsibilities within 
our disclosure system compels restraint. Accountants, like other 
securities professionals subject to Rule 102(e), must make difficult 
judgment calls, navigating through complex statutory and regulatory 
requirements.\168\ In addition, accountants are required to follow GAAS 
and to apply GAAP. These determinations demand the application of 
independent professional judgment and often involve matters of first 
impression.
---------------------------------------------------------------------------

    \168\ One commenter offered an eloquent statement of this core 
issue:
    [GAAP and GAAS] are not like cookbook recipes, where reading 
words and following directions results in a uniform outcome. 
Resolution of many auditing and accounting issues requires judgment. 
Even where there is written guidance, there is often ambiguity. The 
accountant must attempt to synthesize practice and different 
pronouncements that may speak ambiguously or indirectly to the issue 
and that may have changed over time. What the proposed amendment 
labels as a ``violation of professional standards'' is apt to be, in 
practice, a difference of opinion between the Commission's staff and 
the respondent accountant over how a particular pronouncement or 
pronouncements should be applied.
    PricewaterhouseCoopers LLP, CL 116 at 6.
---------------------------------------------------------------------------

    The Commission itself recognized the importance of these principles 
in Carter, when it asserted that, in order to assure the exercise of a 
professional's ``best independent judgment,'' the professional ``must 
have the freedom to make innocent--or even, in certain

[[Page 57185]]

cases, careless--mistakes without fear of [losing] the ability to 
practice before'' us.\169\ Equating negligence with ``improper 
professional conduct'' will impair relationships between professionals 
and their clients. If such an adverse impact occurs, our ability to 
rely on these professionals to enhance compliance with the securities 
laws will be crippled. I share the view endorsed by the Commission in 
Carter that professionals ``motivated by fears for their personal 
liability will not be consulted on difficult issues.'' \170\
---------------------------------------------------------------------------

    \169\ 47 S.E.C. at 504.
    \170\ Id.
---------------------------------------------------------------------------

    Securities professionals owe a duty to serve the interests of their 
clients. To discharge this duty, professionals must enjoy the 
cooperation and trust of their clients. Indeed, in construing Carter, 
Judge Randolph observed:

[W]ithout a scienter requirement, lawyers would slant their advice 
out of fear of incurring liability, and management therefore would 
not consult them on difficult questions. I cannot see why this sort 
of reasoning would not apply as well to auditors. I recognize that 
although companies need not retain outside counsel, they are legally 
compelled to ``consult'' independent accountants * * *. This creates 
an obligation on the part of management to cooperate with and 
provide information to the auditor. * * * There are, however, 
degrees of cooperation. Encouraging management to be completely 
candid with its auditor about difficult accounting issues may be 
just as desirable as encouraging management to consult candidly with 
outside lawyers, and for similar reasons.\171\

    \171\ Checkosky I, 23 F.3d at 485.
---------------------------------------------------------------------------

    The steadfast belief that the Commission must respect the good 
faith judgments made by accountants and other professionals formed the 
basis of my dissent from the Commission's second Checkosky 
opinion.\172\ The outpouring of comment letters highlighting the 
importance of this issue has confirmed and validated my prior 
view.\173\ Even some of those few commenters to support the June 
proposal also recognized the importance of respecting an accountant's 
exercise of independent professional judgment.\174\
---------------------------------------------------------------------------

    \172\ David J. Checkosky, 1997 WL 18303 (S.E.C.), at *14.
    \173\ See, e.g., Richard Y. Roberts, CL 18 at 4; Barbara Hutson 
Gonzales, CPA, McElroy, Quirk & Burch, CL 25; Mike Molinaro, CL 26; 
Daniel S. Kuerner, CPA, CL 33; J. Eric Bjornholt, CPA, Senior Tax 
Manager, Microchip Technology Incorporated, CL 43; Howard McElroy, 
CL 44; Raymond F. Marin, Hixson, Marin, Powell & De Sanctis, P.A., 
CPAs, CL 45; John Sommerer, CPA, CL 46; Edward L. Rand, Jr., Vice 
President and Treasurer, Atlantic American Corp., CL 47; Ronald H. 
Beck, Vice President and Chief Financial Officer, Columbus Energy 
Corp., CL 49; Dan Ramey, CPA, Manager--KEI Operations Accounting 
(``KEI''), CL 60; BDO Seidman, CL 80 at 4 & 8-9; KPMG Peat Marwick, 
CL 82 at 2 & 11-12; Public Company Practice Committee, Colorado 
Society of CPAs, CL 99 at 1-2; Edwards Leap & Sauer, CPA's, CL 102; 
Larry D. Cyrus, CPA, Finance Manager, Ericsson, Inc., CL 106; Dennis 
K. Wilson, Vice President, Finance, and Chief Financial Officer, 
Beckman Coulter, Inc., CL 113; Jim Brausen, CPA, CL 132; Frank H. 
Brod, CPA, CL 137; David D. Gathman, CL 141; SABRE, CL 144.
    \174\ See, e.g., Peter C. Chapman, Teachers Insurance and 
Annuity Association of America (``TIAA'') and the College Retirement 
Equities Fund (``CREF''), CL 8 at 4 (``We recognize that an overly 
broad interpretation of 'improper professional conduct' could create 
an environment of uncertainty in the accounting profession. This 
could impair the investment process by restricting the flow of 
information.'').
---------------------------------------------------------------------------

    Because the fear of Commission discipline will intimidate 
accountants and prevent them from exercising their best independent 
professional judgment, accountants will likely refuse to opine on 
difficult issues or bend over backwards to conform their views to those 
of the Commission's staff.\175\ As a result, financial statements will 
become overly conservative in derogation of the fundamental accounting 
principal of neutrality. One commenter, a professor of accounting, 
stated that he could not support the addition to Rule 102(e) of the 
single negligent act provision for this very reason:

    \175\ Arthur Andersen, CL 98, at 5-7.
---------------------------------------------------------------------------

    I believe that it is important that the SEC foster neutrality in 
financial statements. That is, * * * Rule 102(e) should not foster 
conduct that results in either overstatement or understatement of 
amounts in financial statement presentations and disclosures. The 
rule should therefore foster choosing accounting policies, recording 
transactions and events, and making accounting estimates toward a 
neutral framework. The terminology in the proposed Rule 
102(e)(1)(iv)(B)(1), especially in the light of the discussion in 
the Release and the framework for litigation currently existing, 
does not foster such neutrality. Accountants * * * will increasingly 
be driven to what some have referred to as ``conservative 
accounting'' which can harm the capital market system.\176\

    \176\ Ray G. Stephens, KPMG Peat Marwick Professor, Kent State 
University, [currently serving as Senior Academic Fellow, Office of 
the Auditor of the State of Ohio], CL 42 at 4-5. Other accounting 
academics also expressed strong disagreement with the negligence 
standard in the Proposing Release. See Stella Fearnley and Richard 
Brandt, University of Portsmouth, United Kingdom, CL 161 at 2.
---------------------------------------------------------------------------

The AICPA similarly remarked that the standard in the Proposing Release 
``would chill the provision of the highest quality audit and accounting 
services'' and that ``exposure of auditors to sanctions based on a 
single negligent mistake would introduce an overly conservative bias 
into the financial reporting process.'' \177\
---------------------------------------------------------------------------

    \177\ AICPA, CL 84 at 30-31.
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    Other commenters strongly concurred that the standard in the 
Proposing Release would have a detrimental effect on an accountant's 
neutrality that is contrary to the public interest.\178\ One commenter 
acknowledged that the public does have a legitimate interest in the 
integrity of the Commission's processes, but ``the public also benefits 
from an environment in which accountants are free to exercise their 
independent judgment without fear that a particular judgment might be 
viewed, in hindsight, as subject to sanction by the SEC.'' \179\ 
Another commenter correctly remarked that ``the proposed rule 102(e) 
amendment would have a chilling effect on the justifiable exercise of 
professional judgment * * * contrary to the intent of the Court in 
Checkosky v. SEC.'' \180\
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    \178\ SABRE, CL 144 (``The investing public benefits from an 
environment in which accountants are free to exercise their best 
independent judgment without fear that a particular judgment might 
be viewed as subject to sanction by the SEC.''); see also, e.g., 
Raymond F. Marin, CL 45 (proposal ``would actually diminish the 
vital role of accountants as guardians of the financial reporting 
system''); Edward L. Rand, CL 47 (proposal ``would allow the SEC, 
with the benefit of hindsight, to disagree with [accountants'] 
judgments and thereby subject them to sanctions''; ``[s]uch a system 
is certainly not in the best interest of the investing public''); 
KEI, CL 60 (proposal ``completely out of line with the philosophy of 
accountants being able to make business-related decisions and 
exercise independent judgment in accounting treatment''; proposal 
will cause accountants to be overly conservative); KPMG Peat 
Marwick, CL 82 at 2 (``the proposed negligence standard conflicts 
with the public interest in fostering the exercise of independent 
accounting judgment, free from fear that any individual judgment 
could be second-guessed--with the benefit of 20/20 hindsight--by the 
Commission as part of a Rule 102(e) proceeding''); Dennis K. Wilson, 
CL 113 (``every time one of our professionals is asked to make a 
judgment regarding an issue, the fear of subsequently being deemed 
to have acted inappropriately will be present, which may keep that 
person from adequately considering all available options and may 
unduly impact the ultimate decision made''); David D. Gathman, CL 
141 (proposed rule ``will serve to weaken [accountants'] role as 
guardians of the integrity of the financial reporting system''.
    \179\ Raymond F. Marin, CL 45. Accord Barbara Hutson Gonzales, 
CL 25; J. Eric Bjornholt, CL 43.
    \180\ John Sommerer, CPA, CL 46.
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    In my view, the Standard is no less flawed than that set forth in 
the Proposing Release--it still fails to give adequate protection to an 
accountant's independent professional judgment. The Release's 
discussion of this issue amounts to no more than a conclusory 
tautology.\181\ At the same time the Release professes the Commission's 
deep respect for an accountant's need to exercise independent 
professional judgment--and that this factor has caused the Commission 
to adopt a standard that is purportedly more deferential than that in 
the Proposing Release--the Release emphasizes at least four times, in 
various phrasings, that ``the Commission possesses

[[Page 57186]]

authority, wholly independent of Rule 102(e), to address and deter * * 
* negligent conduct.'' \182\ Likewise, in a reprise of the Commission's 
losing argument in Checkosky II,\183\ the Release expressly states that 
an accountant's subjective good faith will have no bearing on a finding 
of liability under the negligence-based provisions of the new 
standard.\184\ I find these passages positively Orwellian: the 
Commission seems to be saying that if our staff disagrees with an 
accounting judgment call, even if we do not sue you under Rule 102(e), 
we will find a way to sue you for some other violation.\185\ Either 
way, the chilling effect on accountants' professional judgment caused 
by the Commission's return to the discredited in terrorem tactics of 
the National Student Marketing era surely remains the same.\186\
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    \181\ Release at 18-23.
    \182\ Release at 20; see id. at 12 & n.29 (a ``single judgment 
error'' may not subject ``the person committing such an error to 
discipline under Rule 102(e),'' but that person ``would be exposed 
to the sanctions available under * * * other provisions''); see also 
id. at 21 & n.47 (``an isolated error in judgment,'' even if not 
actionable under Rule 102(e), ``could have legal consequences''). 
Accord id. at 23 (noting ``the availability of [Commission] remedies 
other than Rule 102(e) to address ordinary negligence'').
    \183\ 139 F.3d at 224 (referring to Commission argument that 
Rule 102(e) does not require proof of any particular mental state, 
but that mental state was ``relevant only to the choice of 
sanction'').
    \184\ Release at 33 (While the negligence aspects of the new 
standard ``do[] not require subjective inquiry into the accountant's 
intent * * * [, t]he Commission may, however, consider the 
accountant's good faith when determining what sanction would be 
appropriate.'').
    \185\ How times have changed. Barely three years ago, the 
Commission's then-General Counsel disclaimed any resort to 
administrative cease and desist proceedings as a means to circumvent 
the Commission's prudential limitations on bringing ``original'' 
Rule 102(e) proceedings against lawyers. See Lorne & Callcott, supra 
note 19, 50 Bus. Law. at 1316-17; see also supra note 44.
    \186\ See Mary C. Daly, Resolving Ethical Conflicts in 
Multijurisdictional Practice--Is Model Rule 8.5 the Answer, an 
Answer, or No Answer at All?, 36 S. Tex. L. Rev. 717, 781 n.261 
(1995) (``The SEC has been particularly adept at using its licensing 
scheme as an in terrorem weapon to 'encourage' lawyers to police 
their clients to prevent securities law violations.''). Many 
commentators have accused the Commission of improperly using Rule 
102(e) to second-guess a professional's judgment. See, e.g., Kenneth 
J. Bialkin & Chase A. Caro, Issuer Fraud and Financial Reporting, 
692 PLI/Corp 299, 343 & 350 (PLI Corp. Law & Practice Course 
Handbook Series No. B46927, 1990) (Commission has ``used Rule 2(e) 
to second-guess the accountant's professional judgment,'' citing 
cases; ``in many instances [GAAS] call upon the accountant to 
exercise professional judgment, yet the SEC is using its 
disciplinary proceedings to second-guess that judgment,'' citing 
cases; ``[t]he SEC has, in many cases, instituted disciplinary 
proceedings in situations where the accountant's treatment of a 
given issue has a reasonable basis in accounting literature''); 
Downing & Miller, supra note 17, 54 Notre Dame Law. at 789-90; 
Crane, Note, supra note 17, 53 Fordham L. Rev. at 355.
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C. The Costs of The Standard Will Exceed Its Benefits

    The Release asserts ``the Commission continues to believe that the 
amendment will impose no costs.'' \187\ I find this statement highly 
questionable, to say the least. The whole point of the Commission's 
adoption of a new Rule 102(e) standard for accountants and its recently 
announced crackdown on purportedly improper accounting practices is to 
require more care and greater scrutiny on the part of accountants. But 
increased care and scrutiny are not cost-free items. Clearly, 
accountants will have to devote greater time and effort to performing 
audits. I suspect that accountants will pass these costs along to their 
audit clients, as well they should. While one could argue that 
increased care and scrutiny might produce net benefits, one cannot 
reasonably argue, in my view, that they have no associated costs.
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    \187\ Release at 41.
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    Moreover, I disagree that the new standard will produce net 
benefits. Rather, I concur with the numerous commenters who offered 
compelling arguments why the standard contained in the Proposing 
Release will not result in significant benefits.\188\ I do not think 
that the revisions made to the standard in the Proposing Release 
redress these problems, and, accordingly, these comments have equal 
applicability to the Standard. For instance, one commenter asserted 
that, under the standard in the Proposing Release:
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    \188\ E.g., ABA, CL 81 at 7; AICPA, CL 84 at 30-31; Arthur 
Andersen, CL 98 at 6.

audit and tax fees from a continuing audit would substantially 
increase. The steps and costs to take a company public would 
escalate. The difficulty of conducting day to day business affairs 
should the amendment become effective could be staggering.\189\
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    \189\ SABRE, CL 144.

Another commenter stated that the proposed amendment might well ``shift 
the focus to more `CYA' type behavior rather than making sure that the 
information is accurate.'' \190\ A third commenter persuasively argued 
that:
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    \190\ Jay Shah, CL 95.

    If an auditor has to be looking over his shoulder, for fear of 
losing his livelihood, his work will be bogged down in trying to get 
the absolute answer. Labor costs will soar on audits and the public 
ultimately will not be served.\191\
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    \191\ RF[email protected], CL 65.

    The ABA comment letter observed that the standard in the Proposing 
Release could well deprive the public of competent auditors, and that, 
since ``the number of accounting firms providing audit services to 
public companies has declined sharply in the past 20 years,'' this 
decline, combined with the consolidation occurring in the accounting 
profession, might have the effect of increasing audit fees.\192\ I do 
not think the Release adequately refutes these comment letters.\193\
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    \192\ ABA, CL 81 at 7; see also BDO Seidman, CL 80 at 9 (June 
proposal threatens to `` `flush[ ] the baby down the drain with the 
bathwater' '').
    \193\ Release at 37-41.
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    In my view, the costs of today's proposal will substantially 
outweigh its benefits. I have long had an interest in promoting small 
business, and I think the proposal will, in all likelihood, drastically 
increase the audit costs for start-up and small public companies. These 
costs will amount to an unwarranted drag on capital formation.

D. The New Standard Will Unfairly Disadvantage Small Firms

    Several commenters wrote that the standard contained in the 
Proposing Release would unfairly eliminate or lessen the ability of 
small firms or sole practitioners to audit public companies.\194\ I 
think these comments have merit, and that, in this regard, the Release 
shares the same flaws as the Proposing Release. In my view, smaller CPA 
firms can and do play a vital role in auditing public companies, 
particularly smaller public companies.
---------------------------------------------------------------------------

    \194\ See, e.g., Edmond B. (Ted) Gregory, CPA/ABV, CBA, Linton, 
Shafer & Company, P.A., CPAs, CL 22; John G. Ratliff, CL 27; John 
Sommerer, CPA, CL 46.
---------------------------------------------------------------------------

    One commenter noted that raising the level of ``professional risk'' 
might preclude ``many smaller CPA firms from participating in [audits 
of public companies]'' and that ``at least for [small business] 
registrants, * * * smaller CPA firms can often provide better and more 
affordable service.'' \195\ Another commenter similarly remarked that 
the proposed amendment would ``further restrict the participation in 
SEC practice to the few `good ol' boys' who currently dominate in that 
area.'' \196\ The ABA comment letter expressed concern that sanctions 
imposed under the new standard might be applied in a disproportionate 
manner and have a disproportionate effect on smaller firms.\197\
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    \195\ John G. Ratliff, CL 27.
    \196\ John Sommerer, CL 46.
    \197\ ABA, CL 81 at 12; see Touche Ross, 609 F.2d at 582 n.21 
(noting but not deciding unfairness of holding national accounting 
firm with more than 500 partners vicariously liable under Rule 
102(e) for alleged misconduct of two retired partners); see also 
Coppolino, Note, supra note 17, 63 Fordham L. Rev. at 2248 (Under 
Rule 102(e), ``[t]he Commission appears to impose lighter sentences 
on Big Six firms as compared to solo practitioners and small- or 
medium-sized firms.''). Cf. Blinder, Robinson & Co. v. SEC, 837 F.2d 
1099, 1112 (D.C. Cir. 1988) (expressing ``concern'' that SEC may 
impose more disproportionately heavy sanctions on ``small, newer 
[brokerage] firms than it does on old-line, or at least more 
established houses'').

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[[Page 57187]]

    These last comments seem indirectly validated by the Release, which 
notes both that most of the accounting and auditing practiced before 
the Commission is ``conducted by the `Big Five' firms'' and that 
``three of the largest five accounting firms * * * suggested that the 
Commission could appropriately adopt'' the Standard.\198\ It seems that 
these large firms have a different perspective as to the likely effects 
of the Standard on their respective businesses than do their smaller 
competitors.
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    \198\ Release at 21 & 34.
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VI. The Commission Has Failed To Comply With the Administrative 
Procedure Act

    I am more interested in the substance of today's amendment than 
with the procedures used to adopt it. It appears, however, that the 
Commission may not have fully complied with the requirements of the 
Administrative Procedure Act (APA) in adopting the amendment.\199\ In 
particular, I have concerns that the Commission may have failed to give 
adequate notice that: (a) the Standard would apply to conduct occurring 
before its effective date; and (b) as to the subpart (B)(1) of the 
proposed amendment, the standard of ``highly unreasonable conduct'' 
might be adopted.
---------------------------------------------------------------------------

    \199\ 5 U.S.C. 553(b) & (c).
---------------------------------------------------------------------------

    Under the APA, an agency fulfills its obligation to give adequate 
notice if it `` `provide[s] sufficient factual detail and rationale for 
the rule to permit interested parties to comment meaningfully.' '' 
\200\ The general test for whether an agency has to provide new notice 
and resolicit comment on a revised proposal before adopting it, as is 
the case with the proposed amendment to Rule 102(e), is ``whether the 
final rule promulgated by the agency is a `logical outgrowth' of the 
proposed rule.'' \201\ The Release states that the new standard will be 
used in ``all cases considered after the amendment's effective date, * 
* * regardless of when the conduct in question occurred.'' \202\ Any 
potential application of the new standard to conduct occurring before 
its effective date was not mentioned and is not a ``logical outgrowth'' 
of anything contained in the Proposing Release.
---------------------------------------------------------------------------

    \200\ American Water Works Ass'n v. EPA, 40 F.3d 1266, 1274 
(D.C. Cir. 1994) (quoting Florida Power & Light Co. v. United 
States, 846 F.2d 765, 771 (D.C. Cir. 1988)).
    \201\ Id.; see also Omnipoint Corp. v. FCC, 78 F.3d 620, 631 
(D.C. Cir. 1996).
    \202\ Release at 6.
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    As to the ``highly unreasonable conduct'' part of Rule 
102(e)(1)(vi)(B)(1), the situation is less clear. The Proposing Release 
did mention that the Commission was considering possible standards, 
including that of recklessness, other than that proposed.\203\ The 
``highly unreasonable'' standard adopted, however, was not specifically 
mentioned anywhere in the Proposing Release. The Release even admits 
that ``new terminology--the `highly unreasonable' standard'' is 
included in the new rule.\204\ Because this ``new terminology'' was not 
included in the Proposing Release the Commission deprived interested 
parties of the opportunity to comment meaningfully on the new standard 
of liability under Rule 102(e).
---------------------------------------------------------------------------

    \203\ See Proposing Release, 1998 WL 311988 (S.E.C.), at *5.
    \204\ Release at 22 n.49.
---------------------------------------------------------------------------

    Moreover, regardless of whether the Commission has achieved 
technical compliance with the APA, I strongly believe that the 
Commission would have been better served if it reproposed the Standard 
for notice and comment, thereby allowing interested parties the 
opportunity to provide us with their insights on its advantages and 
disadvantages. It is not clear what, if anything, the Commission has 
gained through its rush to adopt the Standard.

VII. The Commission Intends To Expand Its Authority Under Rule 
102(E) Even Further

    Although predicting the future is necessarily an inexact science, 
ominous signs already exist regarding the Commission's intentions to 
expand its authority under Rule 102(e). As previously noted, within 
days of the adoption of the new Rule 102(e) standard on September 23, 
1998, the Commission announced a major new initiative to address 
improper accounting practices.\205\ For the sake of all accountants 
with an SEC practice, I hope that the Commission's recently announced 
crackdown does not represent a return to the days of National Student 
Marketing and Arthur Young, and a new `` `reign of terror.' '' \206\ 
But that remains to be seen. In my view, the accounting profession has 
already sustained irreparable harm from the Commission's adoption of 
the new standard on September 23, 1998. In particular, I believe that 
the new amendment will have a chilling effect on the independent 
professional judgment of all accountants who practice before the 
Commission.\207\
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    \205\ See supra note 6 and accompanying text.
    \206\ Block & Hoff, supra note 37, N.Y.L.J., Sept. 23, 1993, at 
5.
    \207\ Cf. Judah Best, supra note 17, 36 Bus. Law. at 1817 
(noting Rule 102(e)'s ``chilling effect upon counsel,'' and 
referring to Rule 102(e) as ``a vehicle for abuse'').
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    As also noted above, the amendment creates an imbalance between the 
treatment of lawyers and accountants under Rule 102(e).\208\ Although I 
do not foreclose the possibility that a valid rationale may exist to 
justify this disparity, the Release offers none.\209\ The reason for 
this omission was made clear by the discussion at our open meetings on 
June 12, 1988, and September 23, 1998--some at the Commission intend to 
ramp up our Rule 102(e) enforcement program as to lawyers. While I 
still have some hopes that the institutional lessons learned from the 
National Student Marketing debacle might ultimately prevail, it seems 
clear that some at the Commission would like to apply the new Rule 
102(e) standard to lawyers, as well as accountants.
---------------------------------------------------------------------------

    \208\ See supra Section V.A.
    \209\ See Keating, Muething & Klekamp, 47 S.E.C. 95, 110-11 
(1979) (Commissioner Karmel, dissenting) (as result of the 
Congressional grant of power to define accounting terms and to 
require that financial statements be certified by an independent 
public accountant, ``[i]t therefore can be argued'' that the 
Commission may have authority to discipline accountants that it 
lacks for lawyers).
---------------------------------------------------------------------------

    To accomplish this goal, presumably the Commission would have to 
overrule William R. Carter.\210\ Again, I hope these events do not come 
to pass, but I fear that, absent judicial intervention, they will 
happen.
---------------------------------------------------------------------------

    \210\ 47 S.E.C. 471.
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* * * * *
    Unfortunately, although acting in good faith, it seems that the 
Commission is bound and determined to repeat its past mistakes. For the 
good of all professionals who practice before us, as well as the 
Commission itself, investors and issuers, I hope that these matters 
receive definitive clarification sooner rather than later.

[FR Doc. 98-28466 Filed 10-23-98; 8:45 am]
BILLING CODE 8010-01-P