Defending Accountants and Auditors in SEC Rule 102(e) Actions: In-Depth Guide for Counsel
Allegations of engaging in improper professional conduct or violating professional standards may prompt the Securities and Exchange Commission (SEC) to institute disciplinary proceedings against accountants and auditors seeking severe sanctions under the Commission’s Rule 102(e) authority. These actions can threaten the livelihood of practitioners who provide audit, review or attestation services for SEC registrants, brokers, investment advisers and other regulated entities. Successfully defending against Rule 102(e) charges requires experienced counsel intimately familiar with the SEC’s Rules of Practice and case precedents in this complex arena. This article provides an in-depth guide for attorneys representing accountants and auditors facing SEC Rule 102(e) challenges to their professional status.
Overview of the SEC’s Rule 102(e) Authority to Discipline Professionals Appearing Before the Commission
Under SEC Rule 102(e) of the Commission’s Rules of Practice, the Securities and Exchange Commission maintains the authority to censure, suspend or permanently bar from practice before the Commission accountants, auditors and other professionals whose role is necessary or incidental to SEC filings if:
- - The Commission finds they possess a lack of qualifications, character, integrity or ethics after giving them notice and opportunity for a hearing;
- - A court of competent jurisdiction, the Public Company Accounting Oversight Board (PCAOB), the IRS or another professional authority has suspended or barred the person from practicing before it or engaging in the business of auditing or accounting; or
- - A court of competent jurisdiction or the PCAOB finds the person has engaged in unethical or improper professional conduct.
In effect, Rule 102(e) provides the SEC an important disciplinary mechanism and enforcement tool to pursue charges against, and sanctions on, accountants, auditors and other practitioner professionals where evidence suggests they participated in, were complicit with, or negligently enabled clients’ securities laws violations or their work exhibits substantial failures to comply with applicable professional qualifications, standards, ethics rules and duties.
When the SEC believes the conduct of an accountant or auditor may warrant charges under Rule 102(e), it typically institutes an investigation through its Division of Enforcement to gather relevant facts and evidence bearing on the alleged misconduct or professional deficiencies before determining whether to commence formal proceedings before the Commission itself.
Investigations and Recommended Rule 102(e) Charges Against Practitioners
Investigations that may lead to Rule 102(e) charges against accountants and auditors often flow from or run parallel to probes into potential securities law violations like financial reporting fraud, deficient disclosure controls, or inadequate compliance procedures at their SEC-registrant audit clients. Telltale signs can include the opening of a separate investigative matter within the SEC’s Matter Under Inquiry (MUI) system named specifically for the auditor rather than the registrant client.
The SEC Enforcement Division staff conducts fact gathering using investigative tools like document requests and subpoenas compelling production of accounting work papers, communications, time records and other materials illuminating the audit procedures performed, conclusions reached by the practitioner, and their adherence to applicable auditing standards like Generally Accepted Auditing Standards (GAAS) and Public Company Accounting Oversight Board (PCAOB) rules.
Testimonial sworn investigative testimony will also likely be sought from the audit partners, managers and staff involved in the questioned audit work to probe the nature and rigor of procedures performed and probe justifications for audit opinions expressed.
Following its investigation, if the Enforcement Division staff believes it has developed sufficient evidentiary grounds, they will submit a formal recommendation known as an “Action Memorandum” to the Commission laying out the recommended Rule 102(e) charges against the accountant or auditor along with the facts substantiating those charges gleaned during the investigation. This internal recommendation from the Enforcement Division represents the first concrete indication charges are imminent.
The Role of Experienced Counsel in Responding to Recommended Rule 102(e) Charges
The stakes are high anytime the SEC’s Enforcement Division recommends instituting Rule 102(e) charges that could threaten the professional livelihood of an accountant or auditor absent an effective defense. At this critical juncture when charges appear likely, it is imperative for counsel representing the practitioner to engage directly with senior officials within the Division in an effort to dissuade them from recommending charges before the matter escalates to the Commission itself.
Experienced counsel can present well-reasoned arguments why charges are unwarranted or unjustified based on the facts and evidence actually gathered, including submitting a detailed Wells Submission letter and exhibits contesting a recommendation for charges. In some instances, this advocacy at the Division level persuades its leadership not to recommend charges to the Commission after all.
However, if efforts to dissuade the Enforcement Division from seeking Rule 102(e) charges fall short, the combination of presenting a compelling defense before the Commission coupled with rights of federal Appeals Court review of any sanctions imposed provides a robust means for experienced counsel to defend accountants and auditors against charges not supported by sound facts and evidence.
Defending Against Rule 102(e) Charges Through SEC Disciplinary Proceedings
If the Division of Enforcement formally recommends Rule 102(e) charges, and the Commissioners authorize instituting proceedings based on that recommendation, the Commission issues an Order Instituting Public Administrative Proceedings (OIP) laying out the charges against the accountant or auditor respondent. The OIP commences a formal disciplinary proceeding adjudicated by an Administrative Law Judge (ALJ) under the SEC’s Rules of Practice. The charges outlined in the OIP alleging deficient audit conduct or lack of required qualifications or character will typically cite the specific Rule 102(e) grounds for pursuing sanctions. The common grounds alleged include that the accountant or auditor:
- - Engaged in improper professional conduct;
- - Violated applicable professional standards like GAAS or PCAOB auditing rules;
- - Lacks qualifications necessary to represent others before the SEC;
- - Lacks character or integrity; or
- - Committed willful violations of securities laws or rules.
Upon receiving formal notice from the Commission, respondents must answer the Rule 102(e) charges in writing pursuant to Rule 220(b) of the SEC Rules of Practice. The answer allows contesting or admitting specific charges and provides the respondent’s position on the factual assertions and legal conclusions contained in the OIP to frame contested issues for adjudication.
The accused accountants or auditors may choose to settle Rule 102(e) charges at this stage by voluntarily agreeing to sanctions like a temporary suspension or permanent bar from practicing before the SEC through a negotiated settlement offer submitted for Commission consideration along with an executed consent agreeing not to admit or deny the charges.
However, for practitioners seeking to contest charges and avoid draconian sanctions like a bar order that effectively takes away their livelihood and professional reputation absent egregious misconduct, the path forward involves an adversarial hearing on the record before an SEC ALJ followed by rights of appeal.
Successfully defending against Rule 102(e) charges in contested SEC administrative proceedings requires experienced counsel intimately familiar with the Commission’s Rules of Practice, case precedents, common litigation tactics employed by the Division of Enforcement, and strategies that resonate with ALJs. Practitioners should align with counsel that routinely defends SEC enforcement matters before both ALJs and the Commission itself in Washington D.C. to maximize their chances of success.
Effective Hearing Stage Defenses and Litigation Strategies
Effective defenses at the SEC hearing stage are rooted in rigorous preparation combined with exploiting any evidentiary weaknesses or flaws in the foundation necessary to sustain the Rule 102(e) charges against the accountant or auditor.
In proving its case, the Division of Enforcement bears the initial burden of proof and burden of production needing to present sufficient evidence establishing a prima facie case supporting each charged violation of auditing standards, professional requirements or qualifications. If this initial burden is not met, the defense can argue for dismissal of deficient charges before ever needing to present countervailing evidence.
Assuming the Enforcement Division satisfies its threshold burden, common hearing phase litigation strategies for rebutting or defeating Rule 102(e) charges include:
- - Contesting the admissibility of certain documents or testimony the SEC introduces as evidence to support the charges.
- - Introducing materials or calling witnesses that contradict, undermine or rebut the SEC’s evidence and assertions.
- - Highlighting facts and professional judgments demonstrating audit procedures were not deficient but rather compliant with GAAS, PCAOB or other applicable standards given client circumstances.
- - Distinguishing Rule 102(e) precedents the SEC relies upon as involving materially different facts and audit conduct.
- - Arguing the Division failed to eliminate reasonable inferences inconsistent with charges like good faith exercise of professional audit judgment.
- - Citing mitigating factual circumstances for alleged professional deficiencies.
- - Demonstrating the SEC’s theory expands the requirements of professional standards beyond their scope, seeking to pursue charges in the absence of actual violations.
To successfully execute these strategies, counsel should present a hearing defense rooted in both comprehensive understanding of the facts and mastery of the dense auditing requirements and professional standards central to the Rule 102(e) charges. This necessitates substantive and procedural experience litigating before ALJs.
Potential Outcomes and Consequences of SEC Hearings
If the evidentiary record ultimately does not support some or all of the Rule 102(e) charges, the ALJ may dismiss those deficient charges in an Initial Decision which the SEC could choose not to review leaving the dismissal intact. But if charges are factually supported, the ALJ will issue an Initial Decision imposing sanctions like a temporary suspension or permanent bar from practicing before the Commission.
Parties can petition the Commission itself to review any adverse ALJ Initial Decision, but the Commissioners have discretion whether to grant review. If the Commission declines review, the ALJ’s Initial Decision becomes final agency action after 30 days. This triggers rights to appeal the Commission’s final order to the federal Appeals Court circuit where the respondent accountant or auditor resides.
Successfully overturning unfounded charges or unreasonable sanctions requires experienced appellate counsel able to identify potential grounds for vacating SEC orders as arbitrary and capricious or unsupported by the weight of factual evidence. But avoiding sanctions requires defeating charges in the first instance before the ALJ rather than counting on clemency from the Commission or longshot appellate relief.
Given the livelihood implications, counsel should spare no effort advocating at every stage of Rule 102(e) challenges to protect the professional reputation and status of accountants and auditors unjustifiably facing sanctions.
Why Timely Retaining Experienced Counsel is Critical for Contesting Rule 102(e) Charges
Due to the complexity of Rule 102(e) actions and the SEC’s extensive litigation experience, the risks of losing one’s professional livelihood from censure or bar orders is substantial once charges are filed absent experienced counsel guiding a strategically sound defense.
Yet the opportunity exists even after charges are instituted to defeat allegations not grounded in facts and evidence with effective advocacy from counsel intimately familiar with SEC Rules of Practice. We have successfully defended accountants and auditors against Rule 102(e) charges lacking solid evidentiary support or misinterpreting the professional standards at issue.
But far preferable is engaging counsel seasoned in these matters as early in the investigative process as possible if Enforcement Division scrutiny surfaces. The most successful outcomes result from experienced counsel proactively engaging the Division staff at the investigation stage to advocate why no charges are warranted, rather than trying to overcome charges after they are instituted.
We encourage any accountant or auditor facing a worrying SEC investigation or subject to Rule 102(e) charges to promptly engage Lucosky Brookman for candid case assessment and strategic counsel. Please contact us to discuss representing your interests in any SEC proceedings that arise. We are ready to leverage our extensive experience achieved over decades of successful practice before the Commission to protect your professional status and reputation.