SEC, Accounting Fraud, and Professional Malpractice
Andrew Ceresney, the Securities and Exchange Commission's co-enforcement director, in an address Sept. 19, 2013, declared "[t]he importance of pursuing financial fraud cannot be overstated" and "comprehensive, accurate and reliable financial reporting is the bedrock upon which our markets are based because false financial information saps investor confidence and erodes the integrity of the markets." Material misstatements and omissions in financial reporting, however, are not exclusively caused by fraud. The accounting profession, like any other profession serving in the capital markets, must be held to the highest professional standards and therefore focus has to be given to serious professional malpractice in the regulatory context. This should be the case, even where the professional lacks bad intent.
A review of the SEC's recent rule 102(e) proceedings should demonstrate whether the commission is proceeding against accountants not merely for fraud but serious professional malpractice and thereby strengthening investor protection. "Comprehensive, accurate, and reliable financial reporting" as one of the bedrocks of our markets will only be established and maintained when professional standards of competency are emphasized and enforced to the same extent as ethics.
SEC Rule 102(e)
Before an analysis is made of the recent cases to see what categories they predominantly fall in, it is essential to review the text of SEC Rule 102(e)1 to see if the scope of the rule is intended to protect the public investor from the accountant's serious professional malpractice. In essence the commission can suspend or permanently bar an accountant from practicing before the commission (which includes assisting in or causing filings and reports made); (1) if the accountant "[d]oes not possess the requisite qualifications to represent others;" (2) "[i]s lacking in character or integrity or has engaged in unethical or improper professional conduct;" and/or (3) [w]illfully violated or willfully aided and abetted the violation of any of the federal securities laws, rules, or regulations." Clearly the first factor above implicates professional malpractice in the regulatory context..
In the 1998 amendment to Rule 102(e) the commission clarified the Rule's scope as follows:
Rule 102(e) proceedings may also be based on… '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 … covers a single instance of serious misconduct that may not rise to the level of intentional or knowing (including reckless) conduct. [T]his provision applies only to deviations from professional standards greater than ordinary negligence but less than recklessness—when one knows or should know of a heightened risk. The final rule refers to this situation as "heightened scrutiny….
The [Rule]…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." (Emphasis added).
The policy behind this segment of the Rule was explained by the Commission as follows:
Accurate financial reporting is the bedrock of our capital markets. Accountants play a vital role in assuring issuer compliance with the reporting requirements. The Commission wishes 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. The 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.
There is no doubt that the rule extends coverage to professional malpractice, albeit of the most serious nature. The rule's plain language states in the pertinent part: "Either of the following two types of negligent conduct" are within the rule's scope:
(1) A single instance of highly unreasonable conduct that results in a violation of applicable professional standards in circumstances in which the 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." (Emphasis added).