Kpmg, Llp v. SEC

289 F.3d 109 (D.C. Cir. 2002)

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Nature of the Case

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Facts

In January 1995, D wanted to start a separate entity that would provide financial and business consulting services to clients, to that end D entered into a license agreement with KPMG BayMark, LLC (BayMark), and BayMark subsidiaries known as KPMG BayMark Strategies (Strategies) and KPMG BayMark Capital. D agreed to lend $100,000 to each of the four founding principals to be used by them as equity contributions to BayMark and its subsidiaries. D granted BayMark rights to use 'KPMG' as part of its name in return for a royalty fee of five percent of its quarterly consolidated fee income. When P became aware that D was moving forward with the plan, P asked for additional information. P cautioned D against having BayMark provide services to any of the audit clients of D. The advice was ignored and Baymark entered into an agreement with PORTA--a long-standing d audit client-facing financial difficulties--to provide 'turnaround services' and assist it with financing. One of BayMark's founding principals, Edward Olson, would be Chief Operating Officer of PORTA and BayMark would receive a management fee of $250,000 and a 'success fee' based on a percentage of PORTA's earnings, disposed inventory, and restructured debt. PORTA's Board of Directors elected Olson president and Chief Operating Officer of the company. PORTA-Baymark became a continuing top of discussion at the highest levels of D. A number of partners at D engaged their own Department of Professional Practice (DPP) to determine whether it was okay for BayMark to provide services to an audit client and independence concerns with any audit with BayMark running PORTA. P told D to drop the KPMG initials from the BayMark parties' names, to eliminate the royalty fee arrangement, and to bring about the repayment of the $400,000 in loans made to the BayMark principals. D did not inform P of the detailed entanglements involved with PORTA, that one of BayMark's officers was the CEO nor did P know of the success fee arrangement. One of D's employees lied and indicated that P was aware of the PORTA situation and that D audit of PORTA could proceed. When P discovered the PORTA audit, it advised PORTA that D's independence had been compromised and that PORTA's audited financial statements included in its 1995 annual report would be considered unaudited and not in compliance with federal securities laws. An ALJ (administrative law judge) found that under Generally Accepted Auditing Standards (GAAS), D lacked independence from PORTA. The ALJ issued an injunction: egregiousness of D's action, isolated or recurrent nature of the infraction, degree of scienter involved, sincerity of d's assurances against future violations, D's recognition of the wrongful nature of his conduct, and the likelihood that his occupation will present opportunities for future violations. The Commission itself concluded, on the basis of D's debtor/creditor relationship with BayMark and its right to share in Strategies' 'success' fee, that D's independence was impaired under GAAS. The Commission interpreted AICPA Rule 302 to 'flatly prohibit an auditor from 'performing for a contingent fee for any professional services, or receiving such a fee' from a client,' and found that D violated Rule 302 by receiving such a fee. The Commission held that the two impairments (the debtor/creditor relationship and the contingency fee arrangement) 'considered on its own, compromised D's independence and each is sufficient, on its own, to support our finding of violations of Section 13(a) and Rule 13a-1,' The Commission concluded that under Section 21C it could issue a cease-and-desist order for negligent conduct that causes a primary violation of the securities laws and regulations and that D had acted negligently in determining that it was independent of PORTA. P issued a cease-and-desist order. D appealed. D contends that it lacked fair notice of P's interpretation of AICPA Rule 302 and contends that it was improper to impose a cease-and-desist order for a violation of Section 13(a) in the absence of such an order against the primary violator, PORTA, and that it cannot be sanctioned as a primary violator of the securities laws under Rule 2-02(b) of Regulation S-X because that provision imposes enforceable duties only on registrants, not accountants. D in part challenged the propriety of the negligence standard under section 21C and that the order was too vague to be enforced.