Kpmg, LLP v. Securities and Exchange Commission

Second, Mylan’s challenge presents no court’s certification decision as well as the 12(b)(6) question impor- unsettled merits of fundamental its Rule motion to dis- Mylan tance the law class actions. miss because the issues have been careful- 23(f) argues ly briefed, district in ap- that the court erred review under Rule is not Therefore, plying the standards of Rule 23 to the warranted. deny we the peti- case, Mylan of this but not tion for facts does aver review. the district court lacked established guide

law task. Insofar as

Mylan’s objection is upon based the dis- rep-

trict court’s conclusion that the class direct purchasers,

resentatives are the law well guiding that decision also is settled. KPMG, LLP, Petitioner, Brick, 735-36, See Illinois 431 U.S. at at 2069-70. S.Ct. Third, Mylan has a showing not made AND SECURITIES EXCHANGE that, in light of the district court’s discre- COMMISSION, Respondent.

tion, see Hartman v. Duffey, 19 No. 01-1131. (D.C.Cir.1994), the class certification Mylan manifestly erroneous. con- Appeals, United Court of States tends the certified class does not meet the District Columbia Circuit. 23(a)(2-4), requirements Rule namely, Feb. Argued 2002. predominance, typicality, adequacy representation, because members May Decided 2002. occupy class different levels of distribu- En Rehearing and Rehearing Banc Mylan. relationship Upon July Denied 2002. us, however, record before can we conclude that there is manifest error in the

district court’s determination that the class

representatives have standing under Illi-

nois Brick or in the fact findings of under-

lying that conclusion. As the district court

comes to know more about the relation-

ships among Mylan, pharmaceutical

wholesalers, plaintiffs, may class class,

further refine the see Fed.R.Civ.P.

23(c)(1) possibility supports our —a

conclusion that immediate is not appeal

warranted here. hold,

Accordingly, upon applying

standards that we have outlined defin- 23(f)

ing when ordinarily Rule review is Mylan’s

appropriate, challenges

class certification do not warrant interlocu- 23(f).

tory pursuant review Al-

though Mylan would have nonetheless reach

court the merits of the district argued

Michael P. Carroll the cause for petitioner. With him on the brief were S. Flagg Joseph Ronald R. Guerra. Craco, argued Louis A. Jr. the cause and filed the brief for Amer- amicus curiae waived, having al are been Public Accoun- contentions ican Institute Certified fur- the Commission. raised before We support petitioner. tants in that, although the ther hold Commission’s Potts, Litigation Lynn Rada Senior of the basis explanation on reconsideration Counsel, Exchange Com- Securities that there was a risk for its conclusion mission, respondent. argued the cause for ambiguous wheth- might future harm leave were David M. Beck- her on brief With er than one of simply one more Stillman, er, Counsel, Jacob H. General violations would be sufficient meet Solicitor, Conley, Attorney. A. and Michael entry standard for of a cease-and-desist order, ambiguity there no here that HENDERSON, RANDOLPH Before: the on remand would reach ROGERS, Judges. and Circuit deny the Accordingly, same result. petition for review. Opinion by for the Court filed Circuit Judge ROGERS. I. Dissenting opinion by filed Circuit The Commission issued cease-and-

Judge RANDOLPH. following evidentiary hear- desist order an ROGERS, Judge: Circuit commenced, allegations ing that based by of Enforcement and the Division KPMG, (formerly LLP KPMG Peat (together, Office of the Chief Accountant LLP) Markwick, challenges a cease-and- Division”), De- “the with the issuance on by entered and desist order Securities 4, 1997, instituting an cember of Commission, pursuant to Exchange Sec- (“OIP”) proceeding under Commission 21C(a) Exchange of the Act Securities 102(e) of Rule of Practice and Section 21C 78u-3(a), Act”), (“Exchange 15 U.S.C. Exchange evidentiary Act. The hear- of the securi- basis several violations if had en- ing was determine KPMG princi- KPMG regulations. ties laws and vi- gaged improper professional conduct pally contends that Commission lacks and olated Rule 2-02 of S-X authority ancillary authority to turn the 13(a) of the caused violations Section indepen- 21C into an provided thereunder, so, if Act and Rule 13a-l and accountants, dent to sanction failed basis what remedial actions or sanctions would give fair interpreta- notice of novel at the hear- appropriate. be evidence tion Rule 302 of Profession- Code following: revealed the al Conduct of the American Institute of (“AICPA”), as of an effort January part Certified Public Accountants separate entity adopted improper presumption provide and start a that would concluding consulting there was a sufficient risk of financial and services business (then clients, future known as KPMG warranting violations cease-and- KPMG Marwick) into license remedy. desist KPMG also contends that Peat entered BayMark, LLC agreement the cease-and-desist order is overbroad with KPMG although (“BayMark”), BayMark and KPMG and subsidiaries vague. We hold BayMark Strategies did have fair notice the Commis- known as KPMG (“Strategies”), BayMark Capi- interpretation sion’s of AICPA Rule KPMG negli- agreement, could use tal. Under its license properly $100,000 four gence agreed to enforce violations of the lend to each standard founding Act un- used them as Exchange principals and Commission rules BayMark 21C. also and its equity der Section We hold sever- contributions to Once Sturm agreement, Also under the learned that Olson was an subsidiaries. PORTA, inquired officer of BayMark rights again use he as to granted part any independence of its name in return for whether there were con- “KPMG” quarter- fee of of its cerns with audit. Trattou royalty percent five discussed ly Conway, part- fee the matter consolidated income. with Michael DPP; ner in charge they disagreed Perry, partner a senior Glenn as to propriety arrangement, Department Professional Prac- (and Conway Perry) with expressing con- (“DPP”) had met previously tice cern. Commission staff from the Office (“OCA”) After meetings Chief Accountant to discuss inde- several in December BayMark pendence surrounding Conway Perry issues 1995 between and OCA staff, arrangement, and when OCA became OCA staff indicated that in order to concerns, independence forward resolve moving aware that KPMG for would plan, drop with the OCA staff asked KPMG need the KPMG initials BayMark names, from elimi- parties’ additional information. On October 1995, Perry royalty nate manager arrangement, and a KPMG senior fee bring $400,000 met the repayment named Trattou with OCA staff. about Chris meeting BayMark principals. concluded with OCA staff loans made to the BayMark Conway agreed to cautioning against having negotiations KPMG undertake any provide BayMark of the audit clients with to make these Al- changes. services Conway Notwithstanding warning, though of this alerted OCA staff to the KPMG. 3, 1995, Strategies on entered existence of six dual engagements November where agreement, long- Bay- into an PORTA —a KPMG of with was auditor record and clients, standing facing client finan- KPMG audit Mark had contracts with those cial of provide Conway difficulties—to “turnaround did inform OCA staff and it detañed financing. entanglements services” assist involved with Sturm, PORTA, i.e., Olson, outstanding engagement Leonard KPMG’s loan to audit, partner had in- Olson’s as an of and for PORTA’s status officer PORTA BayMark. a principal BayMark, troduced PORTA to of and the Under success agreement arrangement. between PORTA and Strate- fee gies, BayMark’s founding principals, one evidence also showed sometime Olson, Operating Edward be Chief would 27, 1995, before called December Trattou PORTA Strategies Officer of and would Sturm with to Sturm’s earlier answer $250,000 management fee receive a and independence inquiries. Trattou indicated fee” percentage based “success aware Commission was earnings, disposed inventory, PORTA’s au- PORTA situation and that KPMG n 9, and restructured debt. On November proceed. dit of PORTA could On Decem- elected PORTA’s Board Directors 27, 1995, signed en- ber PORTA KPMG’s Chief president Operating Olson and Offi- gagement letter to conduct its 1995 audit. cer of company. When staff the PORTA OCA discovered audit, Conway

Sturm became aware that it informed that KPMG was PORTA-was BayMark the DPP not PORTA because engaging independent and contacted from Bay- changes Bay- okay determine whether was none the structural strategic imple- provide Mark to services to an audit client. Mark alliance had been outstanding mented- a loan okay Trattou indicated that was manage- objection part the Commission had no to it. Olson who was of PORTA’s indepen- conducted “an letter The Commission By ment. of June OCA 3. It indepen- advised PORTA that EPMG’s dent review of the record.” Order at and that compromised concluded, dence had been debt- basis KPMG’s in- audited financial statements PORTA’s relationship and its with Olson or/creditor annual report cluded in its 1995 would be fee, Strategies’ to share in “success” right in compli- unaudited and not considered independence impaired that KPMG’s ance with federal securities laws. Noting admit- under GAAS. that KPMG evidence, impaired

In of this an administra the loan Olson light ted (“ALJ”) GAAS, judge tive law found under under Commis- independence Accepted Generally Auditing Standards as a “seri- sion characterized violation (“GAAS”), independence lacked KPMG from fail- mistake that arose ous” from virtue its loan Olson PORTA ordinary to exercise care maintain ure result, engaged in and that as a Further, independence. Commis- in the charged violations OIP caused “flatly AICPA Rule 302 interpreted sion engage profession in improper but did not ‘perfor[ming] prohibit[] an auditor from 102(e) al conduct under because professional fee ser- contingent for a recklessly. KPMG did not act See Matter for, receiving] or fee’ from vices such L.L.P., 71 Peat Marwick S.E.C. client,” and found that violated (Jan. Dkt. at *32-33 WL by receiving a fee. The Rule 302 such 2000). determining remedy, rela- Commission concluded “these ALJ considered the factors identified individually tionships, whether considered determining relevant to Commission as impaired inde- collectively, [KPMG’s] injunction: egregious to issue an whether pendence.” Order at 32. Because action, ness of the defendant’s isolated or impairments, con- these the Commission infraction, degree recurrent nature of the 02(b)(1) Rule cluded that KPMG violated 2— involved, sincerity of the of scienter defen S-X, § Regulation 17 C.F.R. 210.2- violations, against dant’s assurances future 02(b)(1), requires which that the accoun- recognition wrongful the defendant’s of the was report tant’s “state whether audit conduct, and nature of his the likelihood accept- in generally made accordance with occupation present opportuni that his will addition, auditing ed standards.” for ties future violations. See id. at *34 PORTA violat- Commission concluded that Barboto, (citing Joseph Matter J. 13(a) Act, Exchange ed of the Section n.31, Dkt. S.E.C. 1999 WL 58922 78m(a), 13a-l, § Rule U.S.C. and (Feb. 1999) (quoting Steadman 240.13a-l, § requires C.F.R. which issuers (5th Cir.1979), on aff'd reports independent file certified grounds, other 101 S.Ct. 450 U.S. public re- accountants. The Commission (1981))). 67 L.Ed.2d 69 The ALJ declined peated impairments that each of the two to issue a cease-and-desist order. The (the relationship and debtor/creditor significant ALJ audit considered contingency arrangement) fee “considered (and challenged itself not a second own, inde- compromised [KPMG’s] result), audit reached the same sufficient, own, pendence and each is on its recurring, out growing violations were finding support our of violations of Sec- circumstances,” “highly unusual and 13(a) 13a-l,” Rule Order at of an there no evidence adverse “[similarly, impairment each suffi- impact on investors. See id. at *34. The alone, cient, compromise inde- appealed standing Division to the decision Com pendence under GAAS and to our support mission. Rule2-02(b)(l).” cannot finding primary Or- be sanctioned as a violator of violation 2-02(b) of the at 36. securities laws under Rule der of Regulation provision S-X because that Turning question appropri- of the imposes regis- enforceable duties violations, sanctions for Com- ate trants, not accountants. mission concluded under Section 21C could issue a cease-and-desist order for A. negligent primary conduct causes regula- laws and violation the securities Rule 302 in provides, AICPA rele tions, negligent- and that KPMG had acted vant part: in ly determining independent it was Contingent Rule A fees. mem- 302— result, PORTA. As a the Commis- from practice ber in public shall not issued sion a cease-and-desist (1) for a contingent Perform fee it acted which negligently, KPMG because for, professional services or receive such in of Rule 2- primary resulted violation client fee from a for whom the mem- 02(b) S-X, being and in its performs, ber or the member’s firm of PORTA’s violations cause (a) an audit review of financial 13(a) Act, Exchange 15 U.S.C. statement; 78m(a), 13a-l, § 17 C.F.R. denied 240.13a-l. The Commission (1) prohibition applies above dur- KPMG’s motion reconsideration and period which the member or to the court. appealed firm engaged per- member’s II, In Part we address KPMG’s chal- form any of the services listed above and lenges underlying to the determinations period by any covered fi- historical the Commission’s decision to a cease- issue in any nancial statements involved such III, In Part and-desist order. address listed services. challenges to the cease-and-desist sentence, Except as stated the next order.

contingent fee is a fee established II. performance any pursuant the of service to an in no fee arrangement which will KPMG contends that it lacked fair no- finding be or charged specified unless a First, in respects. tice two it contends it attained, which result is or in fair of the in- lacked notice Commission’s fee depen- amount of the is otherwise terpretation prohibit- of AICPA Rule 302 finding dent or result of such upon the receipt contingent Second, of fees. service. it it contends that lacked fair notice that it be of Public Ac- could sanctioned based on the conduct American Institute Certified (“AICPA”) Leonard Code of Professional of Sturm. KPMG also contends countants negligence Conduct The found impermissible that is basis Rule 302. against arrangement a cease-and-desist order ac- that KPMG’s “success” fee put a of securi- it in a to re- BayMark position countants who cause violation in contingent ties laws or KPMG further ceive fees violation regulations. impose that rule. at 30. This determina- improper contends it was a See Order causing conglomeration order on it that of fee ar- cease-and-desist 13(a) constituted, Exchange rangements at issue violation somehow in against totality, contingent arrange- Act the absence of such an order in their fee violator, PORTA, in afoul of primary and that it ment favor of KPMG runs “perform any profes- PORTA and did

interpretation the AICPA or the Commis- not rather, BayMark; has attached to Rule 302. sional services” for sion ever supposed contingent fee here was not re- that points Amicus out the Com- AICPA royalty ceived from client but was a fee in- recognized that AICPA’s mission has nonclient, aby BayMark. paid au- terpretation generally of its rules is in suggest Commission does not its brief to thoritative, n.67, 26 & Opinion see and previ- that court the Commission has interpretation yet disregarded AICPA’s in interpreted AICPA Rule 302 ously applied incorrectly. Rule 302 and AICPA BayMark’s that would reach “suc- manner defined, that as the term “contin- states Indeed, royalty fee or fee. cess” fee” not reach either “suc- gency does accounting expert testify its did not own paid BayMark fee cess” PORTA or way Rule 302 to be read royalty arrangement BayMark between anything is Commission did. Nor there KPMG, standing alone. This is be- the Com- suggest Congress intended BayMark accounting was not an cause AICPA; fill left gaps mission to firm, not a “member public thus if thing be another would royalty Bay- practice,” and because fees, contingent had own rule on but all pay Mark was committed to KPMG was general requirement has is ac- any “speci- not linked to the attainment of independent. countants be finding fied or result” and its amount was or “dependent upon finding not result” assuming Even the text any professional By other service. Rule 302 reasonably susceptible AICPA lumping separate compensation the two interpretation, pro to the Commission’s as arrangements together, neither which hibiting receiving KPMG from an income Rule violates AICPA amicus con- while it was fi auditing stream PORTA’s “morph[s] cludes the Commission dependent nancial statements into something entirely different than part earnings, size PORTA’s promulgate.” Ami- intended [AICPA] interpretation because that novel Brief cus at 5. rule, reading involves a strained plain language of Rule 302 cannot fair does be said have had “ forbid, it, puts fee/royalty amicus ‘sets of relation- notice that the “success” ar performance ships’ but rather the ser- rangement prohibited would be deemed for, of, receipt contingent vices or the fees the exis- fee AICPA Rule 302. under Checkosky tence or of which are contingent amount 460-61 Cf. (D.C.Cir.1994) particular ‘findings’ opinion or ‘results’ of those (separate Judge case, Silberman). services—in this the audit —not sim- Even when Commission’s involved, on the ‘financial of an own are ply although success audit rules the Com ” words, may rules, client.’ at 5-6. In broadly Id. other the mission construe its rule on its all it every possi face does not cover services and because cannot foresee PORTA, rules, provided only professional may to ble ser- evasion its determine way Or that specific applications vices. at least is the Rule 302 of its rules on a case basis, by prior was understood case the court “cannot defer to Commission’s case, in according interpretation the instant to Commission’s of its testimony expert present- doing penalize of two witnesses if so rules would an individ ual ed The Commission declined who has not fair notice of KPMG. received BayMark. find regulatory Upton that KPMG controlled violation.” v. 75 (2d KPMG, Cir.1996) (citations then, 92, only received a flat from 98 fee omit-

117 ted). Apfel, 107-08, v. process principle that this due 530 Given U.S. 120 S.Ct. 2080, 2083-84, (2000). carries when the rule civil 147 L.Ed.2d 80 applies However, Village see id. the court has penalties, (citing recognized that of Hoff- Estates, Estates statutes Flipside, containing language man of Section Hoffman 489, 498-99, 1186, 25(c)(1), Inc., ground 455 U.S. S.Ct. “or for reasonable failure 1193-94, (1982)), so”, to do a safety 71 L.Ed.2d 362 we hold include valve. See Marine finding Conservancy that the Commission erred that Mammal v. Dep’t of (D.C.Cir. Agriculture, had KPMG violated AICPA 302 as a 1998) BayMark with arrangement (citing examples result as 15 U.S.C. (“reasonable § BayMark’s 78y(c)(l) with arrangement ground PORTA. for failure so”); 160(e) (“extraordi

to do 29 U.S.C. B. circumstances”)). nary See generally Hor mel v. Helvering, 556-59, 312 U.S. Sturm, Regarding Leonard also (1941). 721-23, S.Ct. L.Ed. 1037 If that it lacked fair notice it could contends KPMG failed to raise issue of Sturm’s on his conduct. Spe- be sanctioned based negligence Commission, before the cifically, contends that because question then whether becomes KPMG has challenged staff Commission never provided a explanation reasonable for its propriety throughout Sturm’s conduct failure to challenge Commission’s reli administrative proceedings, for the ance on in issuing Sturm’s conduct predicate Commission cease-and-de- cease-and-desist order. in part sist order on Sturm’s conduct vio- process lated administrative due finding It is clear negligence right fair notice. Amicus AIC- partner based Sturm’s conduct audit PA protests the Commission’s conclusion given way is erroneous the case was simply was negligent rely- that Sturm tried. The did not challenge OCA opinion on the and proceeding DPP’s conduct, commented Sturm’s the PORTA audit. Commission guy” Sturm was “careful who had been maintains, however, because “kept the dark.” The ALJ concluded to raise before failed this issue the Com- good Sturm had acted faith and mission is not before the properly court. object believed that OCA staff “would not 25(c)(1) of Exchange finishing Section the engagements underway.” objection KPMG, provides Act to an Matter Dkt. “[n]o S.E.C. Commission, Nonetheless, order or rule of the which WL at *32. section, is sought may review under this Commission failing criticized KPMG for recognize considered unless it court the seriousness of its actions urged citing before the or there inaction Sturm’s conduct as one ex- ground ample. reasonable for failure do so.” See Order at 11. Reconsideration § 78y(c)(l). purpose light 15 U.S.C. of an OCA chal- absence 25(c)(1) lenge “assur[e] to Sturm’s conduct either in its OIP decision, have or in response had chance address to the ALJ’s challenged before being claims on them in KPMG’s first that Sturm’s conduct notice SEC, 938, Blount 61 negligent court.” v. F.3d 940 would be came when considered (D.C.Cir.1995). statutory provisions Such Commission issued its Order. See Or- Nonetheless, jurisdictional are as a at in seeking serve bar to der 43. recon- Commission, by consideration the court of issues not KPMG sideration previously agency. raised to to find- challenge See Sims failed the Commission’s

118 (1969); Pierce, Administrative 3 194 explains, as to howev- R.J. Sturm. KPMG (2002). Treatise, 970, er, that was not until the Reconsidera- Law at 974 it 15.2 “that it other than tion Order became [the issue].” to raise

pointless C. original opinion In its Commis challenges propri KPMG also it that each of the violations sion stated ety negligence under standard a its independently justified cease- found posi contesting the Commission’s 21C. at 54. and-desist order. See Order Given tion this not properly issue is before this, and the fact that the Commission any “at the court because it was not raised DPP, Conway, found the head of to be proceedings,” point Respondent’s in these well, it negligent might have as been 35, responds Br. that because at object “clearly for to to a useless” previously disclaimed Commission has See Ran sanction for Sturm’s conduct. other authority regulate to accountants Am. v. dolph-Sheppard Vendors Wein 102(e) (and pre than to Rule its pursuant (D.C.Cir.1986). berger, 795 F.2d 105-06 decessors), prosecution proceeded and the difficulty, question The is not without how basis, challenge negligence to on that a Safety subject are to ever. See id. valves 102(e) is under properly standard for Rule abuse, see, e.g., Etelson v. Person Office stan challenge negligence stood as a Management, nel 684 F.2d seek might dard however the Commission (D.C.Cir.1982), losing posi and mere may be regulate accountants. That the absence of circumstances such tion—in But, aof stretch. in its brief somewhat agency it is position as without Commission, argued before clearly or a jurisdiction very to act articu seeking impose the Division was agency position, refusing lated such liability indepen Rule 21C strict under judicial change a rule absent instruction dence and that such constituted violations Randolph- do so—is insufficient. See expansion “an unwarranted de facto 105; F.2d Sheppard, 795 at Marine cf. pbwers profession Division’s to sanction Conservancy, F.3d Mammal at 413. ap als.” KPMG noted that under this plausibly maintains 102(e) Checkosky proach, issue in —at appeal single that a violation both (D.C.Cir.1994)— SEC, v. 23 F.3d at here can type issue suffice issuance would never need to be invoked and cease-and-desist order justify violation of the rules would a cease- finding negligent that Sturm was was not and-desist order. This was sufficient to in place essential. decision leaves Our challenge alert the negligence findings Commission’s authority enter cease-and-desist statutory number of and rules violations of a stan negligence order on basis reasons, For these we need KPMG. Blount v. 61 F.3d dard. See explanation not decide whether KPMG’s (D.C.Cir.1995); Dep’t Treasury 25(c)(l)’s it brings safety within Section (D.C.Cir.1985). FLRA, underlying valve. The rationale exhaus fact, Commission, alerted sufficiently requirements important is issue, ruling negligence suffi possibly behooves court to avoid liability cient to establish under Section “futility” exception expanding when 21C, specifically rejecting unnecessary Randolph- to do so. See reading of 104-05; process due claim on its based Sheppard, 795 see also States, holding Checkosky. Or United court’s See McKart v. U.S. 193-95, 1657, 1662-63, 23 der at & 89 S.Ct. L.Ed.2d 38-39 n.99.

119 merits, applied force in equal On the KPMG’s contention Section 21C Section cannot use 21C proceedings. Commission The nature of the pro- two authority regulate “to bootstrap” ceedings is different. As the Commission grounds. fails on accountants several out, points professional is a “one disciplin- 102(e) First, provides Rule Com- ary designed proceeding protect in a may par- mission sanction accountants integrity process of the Commission’s provided ticular manner. The rule at the while the is a law pro- other enforcement time of the administrative proceeding ceeding,” involving “fundamentally each temporarily could “deny, Commission different remedies-” Br. Respondent’s permanently, privilege appearing or 46. Checkosky, at See 23 at practicing or it” to accountant before Silberman); (separate opinion Judge id. or “engaged improp- who had unethical (separate opinion Judge “willfully er conduct” professional vio- Randolph). KPMG’s view that was any provision lated ... of the Federal by disclaiming jurisdiction to ac- sanction laws.” securities C.F.R. primary countants as violators of securities 201.102(e)(1996). § barring No such justi- law that the Commission was able to here, was nothing entered there 102(e) fy Rule an administrative disci- the rule it is itself indicate that plinary impales rule the same flawed addressing exclusive means for accoun- Likewise, premise. position tants’ conduct. KPMG’s contention'that jurisdiction the federal court has exclusive 102(e) the Commission viewed Rule to be punish over actions to violations of the disciplinary the exclusive basis for actions under 15 securities laws U.S.C. 78aa against accountants is an overstatement: fails to distinguish between the Commis- In Touche Ross & Co. v. authority discipline sion’s professionals (2d Cir.1979), relies, on which KPMG from its substantive enforcement func- the court no more made than historical Checkosky, 23 (sep- tions. See F.3d at 456 statement the rule “the basis Silberman). opinion Judge arate disciplinary proceedings” a number of Third, rejecting challenge to the Commission’s the Commission found that authority discipline and oth- accountants the independence require- violated 2-02(b)(l) ers. Id. at 578. Commission decisions of Regulation ment Rule S-X. contrary. cited are not to the acknowledges Order at 36. See Johnson, See, e.g., Carter S.E.C. indepen- that the has used (1981). is the fact WL 314179 Nor requirement dence as a for as- “baseline Checkosky that in the Commission declined sessing propriety of an accountant’s negligence to take a position whether practice.” conduct under its rules of Peti- 102(e) was sufficient under Rule disposi- words, 26. tioner’s Br. at other tive, maintain; appears as KPMG interpreted indepen- Commission has simply 21C issue before requirements S-X to dence the court. very to accountants. The cases apply KPMG cites include Matter Alan S.

Second, premise of KPMG’s view Goldstein, et 57 S.E.C. 1419 & al. Dkt. Commission’s invocation Sec- 1421, 1994 499304 & 1994 WL 499312 way WL 21C is no more than a to circum- 6, 1994), (Sept. where the requirement vent scienter Rule 102(e) under both censured accountant support is flawed. There is no 102(e) enjoined Rule position culpability predecessor that the standards 102(e) governing proceedings can be the accountant under Section 21C from 17(a)(1) causing der it for a violation Section causing of Section on violations 18a-5(d) 13(a) indepen- lack of the of such an order by Rule virtue of in absence violator, PORTA, implicit argument KPMG’s against primary dence. the discipline necessary pre- is a imposition a primary that it cannot be sanctioned as enforcement under condition to Section under violator of securities laws Rule in the authorities on support 21C finds no 2-02(b) Regulation S-X because that which it relies. provision imposes only enforceable duties Review of registrants, not accountants.

Moreover, virtually the Commission reveals that record before court compelled by Congress’ language choice of objections press failed to these be- KPMG interpret Section 21C enacting Consequently, the Commission. fore “an act or phrase person omission jurisdiction to address them. court lacks knew or should have known would contrib setting negli to such ute violation” as any not show that The record does gence standard. See Order at 38. KPMG legal before the ALJ KPMG’s briefs give contends that the court should no mentioned Commission addressed or interpreta deference to the Commission’s authority of the Commission’s issue regulating tion of 21C as account Section against a cease-and-desist order issue negligence unexplained it is secondary causing or violators without usurpation authority. unsupportable sanctioning primary The Com- violators. plain language in Yet of Section 21C brief to this court makes this mission’s stated, vokes, as “classic the Commission point point, and did not contest the KPMG negligence language.” (citing at 38 Order reply Because its brief. the Commis- Educ., v. County Davis Monroe Bd. of opportunity sion has not had an to address 629, 642, 1661, 1670-71, 143 U.S. 119 S.Ct. contention, it primary violator (1999); v. L.Ed.2d 839 United States Fink not properly before court. elstein, (2d Cir.2000)). 229 F.3d To sought the extent that KPMG reconsidera The record further indicates that ground tion Commission on the any conten effectively abandoned negligent sanctioned it for Commission Regulation apply tion that S-X does not evidentiary hearing on an conduct based directly to accountants. KPMG mentioned standard, held under a scienter we see no post-trial legal brief argument its occasion elaborate the Commission’s stated, event, “In ALJ when it reasoning. at See Reconsideration Order S-X to effec promulgated reconsideration, denying 3-10. registration requirements of Sec tuate pointed the administrative 13(a), 78m(a), which, U.S.C. record where the ALJ had ruled that terms, securities, applies to issuers of 102(e) charged the misconduct under made their auditors.” KPMG no at governed by would be a scienter standard. this tempt elaborate on comment and also Divi noted no other point made mention this else premise had made clear that it would sion proceedings. argument in the An where under litigation charges merely cannot be intimated or hinted a negligence 21C on standard. has raised; “pressed” must be to be response. no Sony preserved. Hays Corp., 847 F.2d D. (7th Cir.1988); In re Fairchild (5th Corp., further Cir. contends that it was 6 F.3d Aircraft 1993); impose Espino, or- see also In Re improper cease-and-desist

121 (11th Cir.1986). 1001, grounds, 1002 Because other Superior Court firmed no mention of this issue in its KPMG made FTC, Lawyers 411, Trial v. Ass’n 493 U.S. or its brief to the Commission motion 768, (1990). 110 S.Ct. 107 L.Ed.2d 851 reconsideration, all indications are that Moreover, does dispute not that argument dropped either or it that under Section 21C may Commission truly an that argument was not violations, impose sanctions such had ever pressed. litigant Where argued never to the Commission that argument” abandon “seem[s] to lacked hold authority to KPMG accounta- agency court hold that not will “the did misrepresenting ble for its independence opportunity have fair this address Independent in its Auditor’s Report. argument.” Broadcasting Busse v. Corp. (D.C.Cir.1996). FCC, 1456, 1461 The Commission’s cease-and-de 25(c)(l)’s purpose Given Section to afford required sist that KPMG cease and opportunity the first committing present desist from or future claims, Blount, 940, address see 61 F.3d at 2-02(b) of Regulation violations Rule S passing cannot conclude that KPMG’s X, being or any present the cause of or an issue was later reference to aban 13(a) future violation of Section of the Ex gave doned that opportu change Act or 13a-l Rule thereunder due nity. to an act or omission KPMG knows or m. should know will contribute to such viola tion, by having any transactions, challenges interests the cease-and-desist variety grounds, order as on a improper relationships or that'would impair inde only one of which we conclude has appar- under 2-01 pendence ent much merit. KPMG makes of the fact addressing S-X or under GAAS. In Congress referred to cease-and- order, challenges our re authority agencies, desist see other view of the Commission’s choice of sanc 19; 101-337, S.Rep. H.R.Rep. No. at No. tion is limited both the Administrative 101-616, contending at that Section (“APA”), Procedure Act 5 U.S.C. gave 21C the Commission no new authori- 706(2)(A) (2000), § and Supreme Court ty regulate professional conduct. But SEC, See precedent. Wonsover v. 205 no authority agen- KPMG cites other (D.C.Cir.2000). 408, 412 F.3d The APA cies had declined to issue cease-and-desist inquiry whether limits our the Commis orders part powers their enforcement “arbitrary, capricious, sion’s sanction who, against although person profes- discretion, or an abuse otherwise not in sional, had found violate been the rele- accordance with law.” 5 U.S.C. vant directly by causing laws either Wonsover, 706(2)(A); 205 413. fact, another violate the laws. Supreme long Court has instructed See, e.g., converse is true. Matter Phil- the Commission’s choice of sanction Zarcone, 93-18, lip C. CFTC Dkt. No. shall disturbed the court unless 1993) (Aug. at *1 WL the sanction is either “unwarranted in law (accountant); Matter Dental California justification Ameri- or without fact.” Ass’n, 1995), (July 1995 WL 452990 v. Light can Power & 329 U.S. grounds, rev’d on other Dental California 112-13, 133, 146-46, L.Ed. 103 (9th S.Ct. FTC, Cir.2000); Ass’n. v. F.3d 942 (cita- Wonsover, (1946); 205 F.3d at 413 Superior Matter Court Trial Lawyers Ass’n, (June omitted). 23, 1986), 107 F.T.C. 510 tions af- found to exist.” FTC practices A. unlawful Co., U.S. 394- Colgate-Palmolive the cease- KPMG contends 1035, 1047-48, 95, 85 13 L.Ed.2d 904 S.Ct. because and-desist order is overbroad (1965). con The order unlike those viola relation to the bears no reasonable cases re demned in the on which KPMG the tions also contends that found. KPMG lies, Baking such ITT Co. Continental unduly by prohibit vague order is because (2d FTC, Cir.1976), 207, 221 v. GAAS, the ing relationships all that violate Sons, Kaplan A Inc. v. Joseph & broad, incorporates open-ended order (D.C.Cir.1965), FTC, 347 F.2d 789-90 interpretation and require standards orders extend where the cease-and-desist punish to exposes possibility KPMG the beyond found. ed the nature of violations making ment incorrect good-faith but is the in v. It also unlike orders NLRB judgments compliance. about Neither Co., 426, 433, Express 312 61 Pub. U.S. persuasive.. contention is (1941), 693, 698, 85 L.Ed. 930 or S.Ct. entry Section 21C authorizes FTC, Corp. Paper v. Swanee fu- prohibit “any to cease-and-desist order (2d Cir.1961), which were not limited provision” found ture violation of the same Chrysler Corp. activities. v. to related to in the case. have been violated instant FTC, (D.C.Cir.1977), 561 F.2d 357 is dis added). The (emphasis 78u-3 U.S.C. case Fed tinguishable because in that 02(b) at are provisions issue eral Trade Commission conceded that 2— 13(a) S-X, Ex- “unintentional,” of the Section marketing violations were Act, change and Rule 13a-l promulgated continuing,” and “confined to two out “not is, advertisements,” no consequently, There provid thereunder.- of fourteen thus justification obey ing wide-rang order law” as less a more “sweeping Tweeds, contends, Country ing ban. Id. at 364. because terms of (2d FTC, Cir.1964), Inc. v. 326 F.2d 144 is these provisions. order are limited to similarly distinguishable given the volun Further, Commission stated.that offending tary of the conduct cessation order “extends to violative acts ‘the only long complaint and the before was filed future threat of which in the is indicated offending party likelihood that the would similarity their because of or relation ” at not resume related conduct. Id. such those acts.’ at 47 [past] unlawful Order 149. n. thus to a 121. extends comprehended by subset of the violations any requirement is there Neither involved, statutory provisions rules and part' on the Commission tailor independence relat-

namely those that are narrowly specific types order more By concluding ed. seriousness provisions violations of involved. misconduct, with the combined “any language in future violation” indepen- in assessing flaws its mode of 21C makes this clear and the “reasonable dence, future created serious risk of requirement impose does not relationship” be- independence-impairing relationships As the ob Supreme such limit. Court issue, yond see the two circumstances at v. served FTC Ruberoid Co. 343 U.S. 54, the justified Order at (1952), 72 S.Ct. 96 L.Ed. 1081 preventing flow- order aimed at violations authority cease-and-desist is “not limited array of independence from broader prohibiting illegal practice impairments precise than the ones found. precise in which it is found to have form doing, In so past. cannot be said existed in the If the objectives Congress order has “no relation to the to attain the envi- reasonable sioned, penalties to confine its required severity monetary it cannot be under anti laws, road lane the trans- block narrow trust that cease-and-desist orders traveled; gressor it must be allowed “sufficiently has should be clear and precise effectively prohib- to close all roads raising questions avoid serious as to their by- goal, may ited so that its order not be meaning and A. application.” Joseph Kap passed impunity.” lan, Id. at (quoting 347 F.2d at 790 FTC Hen Co., would appear 360, 367-68, S.Ct. 803. What KPMG ry Broch & 368 U.S. (1962)). suggest required namely 435-36, an order S.Ct. 7 L.Ed.2d 353 — copy-cat so narrow absence KPMG nevertheless fails to such show that possibility violations there would no questions serious arise to necessarily will ignores violation of the the expan- its detriment. order — Congress. language by sive used Given Section 21C allows for the to en- order the of Congressional purpose empowering join “causing the such [of] violation and the of range Commission “to curb wider any future violation of the provision, same violations” in an effort to “com- securities rule, regulation.” That is all the order recidivism,” 101-337, 1 S.Rep. bat No. at did; it ordered KPMG to “cease and desist (1990); 23-24, 101-616, Rep. see H. No. at from committing violation or future reasonably interpret Commission could 2-02(b) violation Rule S- as empowering 21C to issue X, being or from a cause of any violation specific orders provi- limited 13(a) or future violation of Section of the or regulations sions of law found to have Exchange Securities Act of or Rule 1934 been violated. 13a-l thereunder.” merely Consequently, the record belies KPMG’s the statutory language tracks and inserts contentions that the order bears no rea Further, provisions. although relevant sonable to the and relation violations found may complex be a and rea- GAAS scheme without regard entered the nature professionals may sonable differ as to its of the infraction or good-faith facts, application to discrete sets of is un judgment accountant involved. The set of open-ended indefinite and derlying the Commission’s decision that subject standards whims or independence violations were of an Rather, provi- Commission. as with most der of seriousness KPMG failed law, sions of the are areas of there broad appreciate agency the type expertise is and clarity instances closer to line to which See v. Svalberg courts defer. gen- where there will be some doubt. See SEC, 181, (D.C.Cir.1989); see 876 F.2d 184 F.3d & n. erally Checkosky, 23 at 472-73 7 Blinder, also Robinson & Co. v. 837 (separate opinion Judge Randolph); cf. (D.C.Cir.1988). 1099, 1107 v. Guernsey Hospital, Shalala Memorial 87, 1232, 100-01, 514 115 challenge the cease- U.S. S.Ct. 1239- (1995). rule, 40, vagueness grounds and-desist order on is L.Ed.2d as amended, similarly Ex- February without merit. KPMG contends effective change that because are Act Rel. No. “vague GAAS standards 2000 WL (Nov. open-ended” *1, the Commission could not at Dkt. 1885 S.E.C. 21, 2000), properly enjoin compliance examples with broad includes inde- pro when subjective require interpre pendence lacking, hibitions that will be found and while non-exclusive, tation complex judgments examples over which nonetheless professionals may general reasonable inform the id. at disagree. standard. See observed, in light Although precision impos- This court has is *35. absolute 101-616, standard, at undermine KPMG’s sible, objective see No. even with an FTC, erred Bristol-Myers contention that the Co. (2d Cir.1984), KPMG fails to show that a lower risk of proceeding on the basis of “difficulty applying it will have Com- is required future violation than majority However, order to vast injunction. precise mission’s manner contemplated their future Col- [actions].” is met unclear which standard U.S. at gate-Palmolive, 380 S.Ct. Commission’s analysis recon- from the aware, But, if a as 1047. situa- sideration. un- “sincerely KPMG is arises where original the Commission opinion, In its a proposed able to determine whether acknowledged that: present course of action would violate

order, oblige can ... the Com- [KPMG] sanctions, traditionally imposing advice give ... definitive mission variety mitigating have balanced a pursued, if action proposed [the] whether circumstances, aggravating such as compliance with the or- would constitute violations, the harm caused disagreement If der.” Id. KPMG has a violations, the extent seriousness of its interpreta- with the Commission enrichment, wrongdoer’s unjust of the standard, tion of a it will have GAAS wrongdoer’s disciplinary and the record. opportunity to make the case for inter- are questions poses The this wheth- case pretation any contempt in proceeding er, statutory as a matter of either com- adjudicate an may institute to mand or in the exercise of our broad violation of the alleged order. discretion, require showing we will some violations before of likelihood of future B. order, a issuing cease-and-desist however, More problematic, may made. showing how that that in entering KPMG’s contention Order at 46. The Commission had stated order, cease-and-desist the Commission single that a violation sufficed show presumption a improper created an that at necessary likelihood. See id. 54. On past violation is sufficient evidence reconsideration, explained the Commission violation, of future and applied “some risk” that, history leading up consistent with arbitrary it in an and capricious manner 21C, to the enactment of Section it had is, irrebutable,” essence, “in whereby a showing risk of applied standard ignoring of serious KPMG’s evidence significantly future less violations was finding remediation and there ALJ’s required injunction. than that for an See seeking no future threat of In harm. at 10. To the Reconsideration Order Commission, reconsideration Commission, “although risk’ fu- ‘some argued Commission had necessary, ture it need not be violations is comply failed to with the that it standard great issuing very warrant cease-and- had of a established for issuance cease- in ordinary order and that case desist namely and-desist likelihood some order — contrary, and absent evidence to proof of future violation based of some finding past violation raises sufficient continuing or threatened conduct Disclaiming of future Id. risk violation.” creating an increased likelihood that issuance of a cease-and-desist order future violations—and that there no violation, past plain language finding such The “automatic” on a evidence. of Sec- 21C, legislative history, “[a]long as well as the the Commission stated that 101-337, 18; violations, see we will S.Rep. H.R.Rep. No. at the risk future contin- in our traditional factors and are more adequate ue to consider whole than or- determining a cease-anddesist our support whether conclusion that there was on the appropriate der is an sanction based just risk but a ‘some’ ‘serious’ risk of Id. entire record.” violation, which, future together with the sanctioning traditional we reject factors consid- proceeded ered, fully warranted the con- cease-and-de- argument that the violative isolated, inadvertent, added) sist relief issued. (Emphasis duct was and uncon- or any ongoing engage- nected to conduct Id. at 11. Rather, explained, ment. the Commission although “the nature of the isolated The Commission’s statement on recon- against re-

violations tended counsel suggests sideration that it nomay longer not, not, lief. ... do consider, we did consider clear, initially as it made see the lack of at levels at- care senior any Order one findings of its independence tended the determinations violation, alone, standing would suffice merely this case to have been inadvertent under its standard to enter a cease-and- con- ongoing be ‘unconnected’ to desist order. At oral argument counsel duct or at 11. risk engagement.” Id. argued for the Commission that the lan- here, of future violations arises the Com- guage the Reconsideration Order is in- in- explained, mission “from the manifestly sufficiently precise to suggest adequate scrutiny given level to inde- changed Commission had mind. pendence [KPMG’s] issues consistent truth, the Reconsideration Order leaves recognize failure this the seriousness of Nevertheless, light this unclear. misconduct.” Id. The then Commission having Commission’s found several serious Olson, noted that loan to an officer of a one violations—all but of which we af- was, witness, registrant, in the words of a firm —we conclude a remand is unnec- “an absolute out-and-out blatant violation” McNulty essary. Sec’y See & v.Co. of More specifically, of GAAS. Id. the Com- Labor, 328, (D.C.Cir.2002). mission stated: original The Commission stated in its impairment, We found that this well as outstanding order that either the loan or impairment flowing as from fee/royalty arrangement, the “success” right a to receive fee contin- [KPMG’s] alone, standing compromised in- KPMG’s gent registrant’s on the success viola- [in dependence and that “each of the viola- 802], tion of AICPA Rule in resulted today independently tions we have found serious [KPMG] violations and calls for cease-and-desist relief.” Order at appreciate failed to that seriousness. reconsideration, 54. On We also determined that the violations multiple continued to find violations suf- negligent flowed from the failures of the ficient to seriousness warrant cease-and- head of DPP [Conway] [KPMG]’s relief desist under either a “some-risk-of- partner the audit to inform [Sturm] future-violation” standard or a “serious- spe- about themselves facts material to risk-of-future-violation” standard. Recon- cific about independence issues attend- Removing sideration Order 11. engagement [KPMG]’s audit —when finding Commission’s erroneous questions both had or concerns about violated AICPA 302 still propriety ready audit and had what access to relevant leaves was characterized as “an abso- information. These findings, well as others lute blatant out-and-out violation” of detailed GAAS our opinion, are a based on record as the form of the loan Olson. Order at im- may 30; mission’s determinations that Order at 11. Similar- Reconsideration 21C on sec- removing negligence pose sanctions under Section ly, alleged Sturm, sanctioning perhaps only ondary “careful also who was violators without “strategic violators, in the alliance” guy” involved S-X primary leaves, still BayMark, between KPMG and may directly to accountants. Final- apply least, negligence of very at the “the a to allow the ly, we conclude that remand Department of Profes- [KPMG’s] head clarify simply whether one who, Practice,” according Conway, sional more of two or combination Commission, “manifestly rendered meet it found suffice to its stan- violations inde- scrutiny ... inadequate level finding a risk of future violation dard for scrutiny most pendence issues” when enter a unwar- cease-and-desist 11. Order at needed. Reconsideration light ranted in of the Commission’s alter- circumstances, and these consistent Under original in its findings native of violations we conclude remanding when deny peti- order. We therefore significant chance that but “that there is a review. have agency might error [an] result,” McNulty, 283

reached a different RANDOLPH, Judge, dissenting: Circuit Utah, (citing F.3d at 339 Envirocare of Comm’n, 194 Regulatory Inc. v. Nuclear I cease and desist believe SEC’s (D.C.Cir.1999)), conclude be vacated remanded order should meaningless re- would be “[i]t agency.' Wyman-Gordon, mand.” NLRB v. opinion, first SEC nodded n. 766 n. U.S. S.Ct. some favor of need find risk (1969). 22 L.Ed.2d 709 precondition future misconduct as a IY. cease and desist order. But it then turned held evidence to “[a]bsent around and fair Accordingly, because lacked contrary, finding violation raises interpretation notice of the Commission’s risk of sufficient future violation.” the Com- AICPA Rule we reverse conclusion, this and on recon- challenged finding that the “success” mission’s expressly the sideration SEC disclaimed rule. fee/royalty arrangement violated that that is any notion a cease and desist order As that it also to KPMG’s contention the after a violation of securi- “automatic” lacked fair notice it could be sanctioned on said it continue to ties laws. SEC will conclude, conduct, the of we basis Sturm’s consider “our traditional factors” before disposition view of our and the Commis- order, which, a cease and imposing desist not position appeal, sion’s on that we need opinion, ap- the according to SEC’s first failure chal- decide whether KPMG’s to to “the harm the viola- pear caused to lenge finding the Commission’s as (here none), tions” “the seriousness of the safety Sturm falls within the valve of Sec- violations,” wrongdoer’s “the extent 25(c)(1). tion affirm the Commission’s We (here none), unjust “the enrichment” and negligence appro- determination that (as wrongdoer’s record” ac- disciplinary priate underlying a basis for violations order, knowledged argument, meager at oral and Section 21C cease-and-desist best). reconsideration, opinion In its on reject KPMG’s contentions the order “findings” (1) not wrote that its vague. and Because SEC overbroad — (2) Commission, Olson; ar- contingent not loan to fee raised before the we do (3) remorse; challenges rangement; address to the Com- KPMG’s lack KPMG’s (4) part- of the KPMG desist order. It was negligence only reconsidera Sturm, Conway including ners all the SEC made an about-face and prior which discussed in the sentences— lumped findings together. all the Given adequate support than [the were “more to this posture, and fact the SEC ... conclusion there was SEC’s] well, Conway be negligent found to violation, which, to- serious risk future “clearly would have been useless” gether sanctioning fac- with traditional object to imposition of a sanction considered, fully tors we warranted for Sturm’s conduct in its motion for re SEC] cease-and-desist relief issued.” [the consideration. See Randolph-Sheppard Weinberger, Vendors Am. v. contingent finding fee SEC’s (D.C.Cir.1986). 90, 105-06 face, clearly erroneous. On its AICPA’s all provided Rule 302 covers not services The reconsideration criticizes order professional but Systems, to Porta recog- KPMG for its “consistent failure to services. Rules of Professional Conduct nize seriousness” of its violations. Inst, (American § 302 Pub. Certified True, vigorous KPMG mounted defense 2001). interpreta- Accountants The SEC’s ease, but charged the SEC’s those tion of rule receives no deference be- right misconduct have a to defend them- Congress cause have hint that in- no Also, it is arbitrary selves. the SEC fill tended the left gaps SEC fault not seri- recognizing KPMG for thing It AICPA. would be another entire- ousness Sturm’s so-called misconduct ly if its own rule on contin- the SEC had praised when SEC enforcement staff fees, gent agency but all the has is its his behavior. general requirement accountants be light finding errors in SEC’s 210.2-01. independent. See C.F.R. contingent arrangement finding fee and in negligence It clear is also SEC’s negligent, Sturm or- cease desist finding based Sturm’s conduct is erro- der cannot be have sustained. should We way neous given the the case was tried. vacated the and sent the case back charge wrongdoing There was no re- so still the SEC could decide whether it garding Sturm. At trial before the Ad- legs wants issue the order without these Judge, ministrative Law SEC enforce- of the table. ment careful guy” staff called Sturm “a “kept who was in the dark.” As I would therefore not reach objection bring failure this other issues in the case. require we do that a party raise arguments when would futile See, FCC, e.g., Corp.

do Omnipoint so. (D.C.Cir.1996). original explicitly

SEC’s stated opinion issuing each its four reasons for justified independently its cease and

Case Details

Case Name: Kpmg, LLP v. Securities and Exchange Commission

Court Name: Court of Appeals for the D.C. Circuit

Date Published: Jul 16, 2002

Citation: 289 F.3d 109

Docket Number: 01-1131

Court Abbreviation: D.C. Cir.