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Federal Appeals Court Reverses PCAOB and SEC over Denial of Ernst & Young Expert Witness
April 3, 2018
You know when you read something that's "official" and, at first blush, it doesn't make sense? Of course, you figure you must have missed something, so you re-read it but, gee, it still doesn't make sense. Then you look at the heading of the document and it's from some governmental agency or court and you figure that they must know what they're talking about and, after all, I'm just an idiot. At this point, you often go back, re-read the thing a third time but now assume whatever is necessary to bring reason to the pages and you relinquish all sorts of objections that get in the way. Voila, it now all makes sense! Of course, you may also wind up walking away as did Galileo muttering "And yet it moves." Speaking of walking away and how things still move, I recently followed a mess involving the PCAOB, the SEC, and a Ernst & Young audit partner. The E&Y audit partner came within the crosshairs of PCAOB and was suspended and fined, which the SEC affirmed. Frankly, I didn't feel much sympathy for the guy and felt and still feel that PCAOB had him dead to rights. On the other hand, when the PCAOB was investigating the audit partner, they scheduled an interview at which he was accompanied by a lawyer employed by E&Y. Not my preferred manner of representation given the potential for conflicts in such cases but it's common enough that it's not that big a deal. On the other hand, PCAOB denied the lawyer's request to be accompanied by an accounting expert, who was also an E&Y employee. As best I could understand PCAOB's position on denying the expert's attendance, the regulator kept saying that it didn't want an employee of the firm present at the individual's interview -- but, you know, I kept noticing that the lawyer representing the individual was an E&Y employee and, hey, what's up with that? How come it's okay to have one E&Y employee present at the interview but not another? Seemed to me that PCAOB was sort of making it up as it went along.
PCAOB / SEC
The Public Company Accounting Oversight Board ("PCAOB") investigated an Ernst & Young audit under the auspices of audit partner Mark Laccetti. During the PCAOB's investigation, it allowed Laccetti to be accompanied at his interview by an Ernst & Young lawyer but denied his request to also be accompanied by an accounting expert, who would purportedly assist the lawyer. Following a PCAOB disciplinary action, Laccetti was found to have violated PCAOB Rules 3100 and 3200T by failing to adhere to professional auditing standards during the audit of a company's financial statements. PCAOB found Laccetti's conduct during the audit was reckless and barred him from associating with a registered public accounting firm, with leave to petition to associate after two years, and imposed an $85,000 civil penalty.
On appeal to the Securities and Exchange Commission ("SEC"), Laccetti did not challenge PCAOB's findings of liability or imposition of sanctions but solely asserted constitutional and procedural challenges to the proceedings. In the Matter of the Application of Mark E. Laccetti, CPA for Review of Disciplinary Action Taken by the PCABO (Opinion, SEC, '34 Act Rel. No. 78764; Admin. Proc. File No. 3-16430 / September 2, 2016). http://brokeandbroker.com/PDF/LaccettiPCAOB.pdf. As set forth in the SEC Opinion in pertinent part:
[F]irst, he argues that the Board's Final Decision must be dismissed because the Board's structure during the Division's investigation and institution of proceedings violated the Constitution's separation of powers. Second, he argues that the Division violated his right to counsel by refusing to allow an accountant employed by Ernst & Young to accompany his outside attorney during Laccetti's investigative testimony. Third, he argues that the Board lacked constitutional authority to impose sanctions because its members had not taken oaths of office or received Presidential commissions. Based upon our review, we conclude that none of these arguments has merit.
Page 8 of the SEC Opinion
In affirming PCAOB, the SEC addressed Laccetti's argument about his denied right to counsel [Ed: Footnotes omitted]:
Page 17 of the SEC OpinionThe Board concluded that Laccetti was not denied a right to counsel by the Division's refusal to permit an accountant employed by Ernst & Young to sit in on Laccetti's investigative testimony as a technical consultant. As an initial matter, no constitutional or statutory right to counsel exists in PCAOB investigatory proceedings; therefore, the only conceivable basis for Laccetti's claimed right relates to a PCAOB rule providing that witnesses may be accompanied by counsel.68 But that rule is expressly limited by the PCAOB's discretion to exclude anyone other than certain enumerated individuals at the testimony. In this case, Laccetti was represented by outside counsel at his testimony. The Division properly exercised its discretion to exclude another accountant employed by Ernst & Young, from Laccetti's investigative testimony session given its concern about the potential for personnel from Laccetti's employer to monitor or influence the investigation. And even if the exclusion of Ernst and Laccetti next argues that the PCAOB'sYoung's accountant was in error, Laccetti was not prejudiced because the investigatory testimony was not a basis for the PCAOB's Final Decision and Laccetti presented evidence and testified at the hearing.
In providing further rationale for its findings, the SEC added that:
Pages 19 - 20 of the SEC Opinion
Laccetti next argues that the PCAOB's rules providing a right to counsel also establish a right to a technical expert consultant (in this case an accountant employed by Ernst & Young's General Counsel Office) during investigative testimony. Those rules provide only a limited right to counsel that is narrower than the APA's and does not encompass the absolute right to a technical expert consultant.PCAOB Rule 5109(b) provides that a person appearing in a Board investigation "may be accompanied, represented and advised by counsel, subject to Rule 5102(c)(3)." (emphasis added). Rule 5102(c)(3), in turn, limits those who are permitted to be present at an investigatory examination to: the witness and his or her counsel, any Board member or staff of the Board, the reporter, and "such other persons as the Board, or the staff of the Board designated in the order of formal investigation, determine are appropriate to permit to be present; provided, however, that in no event shall a person other than the witness who has been or is reasonably likely to be examined in the investigation be present." (underlining in original).Rule 5109(b) does not entitle a witness to a technical expert at investigative testimony, -- and 5102(c)(3) places that determination squarely in the hands of the Board or its staff. Laccetti reads Rule 5109(b)'s right to counsel as encompassing the right to have a technical expert consultant at his examination, based on a district court case, SEC v. Whitman, in which the court read the APA's right to counsel to include a right for that counsel to be accompanied by an expert consultant, at least on "those limited occasions when a technical adviser is deemed by the witness' attorney to be essential."
DCCir
Laccetti appealed to the United States Court of Appeals for the District of Columbia Circuit (the "DCir") Mark E. Laccetti Petitioner, v. Securities and Exchange Commission, Respondent (Opinion; DCCir; 16-1368 / March 23, 2018) http://brokeandbroker.com/PDF/LaccettiDCCir.pdf
On appeal, Laccetti argued that PCAOB infringed his right to counsel by unreasonably barring the accounting expert from assisting his lawyer during the interview.
On appeal, Laccetti argued that PCAOB infringed his right to counsel by unreasonably barring the accounting expert from assisting his lawyer during the interview.
In arguing that it was appropriate to bar the expert, PCAOB cited its:
Page 3 of the DCCir OpinionRule 5109(b) provides: "Any person compelled to testify" in a PCAOB investigative interview "may be accompanied, represented and advised by counsel . . . ." Rule 5102(c)(3) further allows the Board to limit attendance at the interview to "(i) the person being examined and his or her counsel . . . and (iv) such other persons as the Board . . . determine[s] are appropriate . . . ."
In justifying its exclusion of the expert, PCAOB explained that it had;
Page 3 of the DCCir Opiniondenied Laccetti's request because Laccetti's expert was employed at Ernst & Young. The Board did not want Ernst & Young personnel present for the testimony of the Ernst & Young witnesses because it apparently did not want Ernst & Young personnel to monitor the investigation. That was the sole reason provided by the Board for denying Laccetti's request.
In granting Laccetti's petition and vacating the SEC's Order and remanding with directions to the SEC to vacate PCAOB's orders and sanctions, DCCir barely disguised its exasperation with PCAOB [Ed: Footnotes omitted]:
First, the arbitrary and capricious standard requires that an agency's action be reasonable and reasonably explained. Here, the Board's explanation for denying Laccetti's request was not reasonable.An Ernst & Young employee was already planning to attend (and did attend) Laccetti's interview - namely, the Ernst & Young attorney who accompanied Laccetti. Consistent with Board policy and relevant ethics rules, that Ernst &Young attorney could act as attorney for both Laccetti and the company. See PCAOB Release No. 2003-015 at A2-19 (Sept. 29, 2003). Given the presence of the Ernst & Young attorney at the interview, the Board's rationale for excluding the Ernst & Young accounting expert - that the Board did not want Ernst & Young personnel to be present -- makes no sense here.In its brief and at oral argument, as in the underlying agency orders, the Board has offered no good response to this point. The Board has simply repeated again and again that it had discretion to exclude an Ernst & Young accounting expert so as to ensure that Ernst & Young personnel could not monitor the investigation. Repetition does not equal logic. The Board's explanation, even when oft repeated, is not logical given the fact that an Ernst & Young attorney attended Laccetti's investigative interview. Pressed hard on this precise point at oral argument, the Board's capable counsel ultimately could muster no response and retreated to the Board's backup argument that any error by the Board in denying Laccetti the assistance of an accounting expert at his investigative interview was harmless error. See Tr. of Oral Arg. at 34-36.
Page 4 of the DCCir Opinion
Further DCir admonished that
[E]ven if the Board wanted to bar an Ernst & Young affiliated accounting expert, that explanation would not justify the Board's denying Laccetti any accounting expert. Instead, the Board could have told Laccetti that he could bring to the interview an accounting expert who was not affiliated with Ernst & Young. The Board did not do so. Rather, the Board's letter to Laccetti flatly stated that "the presence of a technical expert consultant" is "not appropriate at this time." JA 458.
Page 5 of the DCCir Opinion
In circumscribing its ruling, DCCir allowed that:
[T]he Board's rules grant the Board discretion to exclude "other persons" from an investigative interview as the Board deems "appropriate." But that grant of authority does not entitle the Board to infringe the right to counsel. . .Under the Board's rules, the Board therefore may not bar a witness from bringing an accounting expert who could assist the witness's counsel during an investigative interview. (To prevent monitoring, the Board may exclude a company affiliated accounting expert when no other company-affiliated personnel are allowed at the interview.) To be clear, the Board is always free to change its rules, subject to constitutional and statutory constraints. Our holding on this point is therefore exceedingly narrow. All we conclude in this case is that the Board, under its current rules, must allow a witness the assistance of an accounting expert when such an expert could assist counsel at an investigative interview.
Page 7 of the DCCir Opinion