Checkosky v. Securities and Exchange Commission

Accountants David Checkosky and Norman Aldrich (accountants) (defendants) performed audits of Savin Corporation. The accountants certified that Savin’s financial statements complied with generally accepted accounting principles (GAAP) and that their audits complied with generally accepted auditing standards (GAAS). However, the Securities and Exchange Commission (SEC) (plaintiff) determined that Savin’s financial statements for May 1980 through December 1984 improperly characterized certain research and development costs, resulting in more favorable accounting treatment for Savin. In 1987, the SEC brought an administrative disciplinary proceeding against the accountants pursuant to SEC Rule 102(e)(1)(ii), alleging they engaged in improper professional conduct. An administrative law judge ruled against the accountants and suspended them from practicing before the SEC for five years. The SEC affirmed the finding of improper professional conduct although it reduced the suspension to two years. In doing so, the SEC effectively stated that negligence was sufficient to constitute improper professional conduct under the rule. The accountants petitioned the United States Court of Appeals for the District of Columbia Circuit for review, which in 1994 remanded the case to the SEC because the SEC had failed adequately to explain the requisite mental state to constitute improper professional conduct. On remand, the SEC affirmed the suspensions in 1997. However, the SEC continued to decline to define the necessary mental state, instead declaring that no specific mental state was required and that negligence (or maybe less in the case of certain isolated or even innocent circumstances) could be enough to constitute improper professional conduct if a violation of GAAP or GAAS threatened the integrity of SEC processes. The accountants again petitioned the DC Circuit for review, arguing that, among other things, the SEC failed to articulate an intelligible standard for finding improper professional conduct.