PricewaterhouseCoopers LLP August 20, 1998 BY E-MAIL AND US MAIL Jonathan G. Katz, Secretary United States Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Dear Mr. Katz: Re: Comments on Proposed Rule 102(e) Amendment; File No. S7-16-98 PricewaterhouseCoopers LLP (?PwC?) submits these comments on the proposed amendment to the Commission?s Rule 102(e) to define ?improper professional conduct? as applied to certified public accountants. At the outset, PwC realizes that the proposed amendment reflects a commendable effort to add clarity to a definition that, in the past, has been vague and ambiguous, and has allowed almost completely unbridled discretion. Unfortunately, for reasons explained below, we believe the proposed amendment falls short of a solution to the problem. We respectfully request that the Commission take more time to seek the views of knowledgeable persons, and also that the Commission consider any proposed amendments to Rule 102(e) in the broader context of all securities professionals, not just certified public accountants. Any attempt to define the basis for the institution of a Rule 102(e) proceeding should have application to all professionals who practice before the Commission. It is inappropriate and unfair and may be legally untenable to single out certified public accountants alone. 1. Any proposed change to Rule 102(e) must, of course, conform to limits on the Commission?s statutory authority. In this context, it should be understood that Congress has never granted to the Commission the power to engage in a de facto regulation of the accounting profession. The vagueness of existing Rule 102(e) and a practice that permitted unbridled discretion has troubled the federal courts in part because it appears to amount to an attempt at de facto regulation. See Checkosky v. SEC, 23 F.3d 452 (D.C. Cir. 1994); (Checkosky I); Checkosky v. SEC, 139 F.3d 221 (D.C. Cir. 1998) (Checkosky II). Because the proposed amendment likewise fails to give adequate clarity and provide clear limits to discretion, it presents the same problem. 2. The reference to ?applicable professional standards? throughout the amendment unnecessarily introduces ambiguity. Generally accepted accounting principles (?GAAP?) and generally acceptable auditing standards (?GAAS?) are the applicable standards that govern the conduct of a certified public accountant. Any reference to standards should refer specifically to them. 3. Subpart (A) of the proposed amendment refers to ?an intentional or knowing violation, including a reckless violation, of applicable professional standards ?.? The reference to an ?intentional or knowing violation? is a commendable effort to add clarity and clear limits, but the phrase ?including a reckless violation? immediately introduces the ambiguous, slippery concept of ?reckless? conduct. The U.S. Supreme Court has never in the context of federal securities laws held that ?reckless? conduct is the equivalent of scienter. See Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). Some lower federal courts have defined a concept of recklessness that they have considered equivalent to scienter, but the proposed amendment to Rule 102(e) fails to include a comparable definition of what constitutes ?reckless? conduct. In any event, we agree with the Commission that any such reckless conduct should be a form of ?intentional or knowing? conduct. 4. Subpart (B) of the proposed amendment moves beyond ?intentional?, ?knowing? or ?reckless? violations of professional standards. Subpart (B) would provide that improper professional conduct occurs where there are ?repeated, unreasonable violations of applicable professional standards that demonstrate that the accountant lacks competence.? Again, we commend the effort to provide guidance, but, once again, the proposed language falls short. We agree that Rule 102(e) should not be triggered simply where there is a violation of professional standards, but it is unclear what in the Commission?s mind ? or more particularly, the mind of its professional staff ? will constitute ?repeated unreasonable violations.? A situation that regularly arises in accounting and auditing practice is that a judgment about the interpretation or application of the same accounting principle or the same auditing standard is repeated in the recurring audits of the financial statements of a client for successive years. The Commission?s statement accompanying the announcement of the proposed amendment does not specifically address the situation, but it gives no comfort that the Commission?s staff would not consider such a situation to present ?repeated? conduct. We submit that language requiring ?a course or pattern of unreasonable conduct showing repeated failure to conform to GAAP or GAAS or the Commission?s rules and regulations relating to financial reporting? better captures what should be the Commission?s legitimate objective. 5. Similarly, the phrase ?lacks competence? in Subpart (B) is also vague. We submit that where an accountant is subject to Rule 102(e) because of his incompetence, the Commission should be required to demonstrate that the respondent accountant is so lacking in competence that continued practice before the Commission represents a future threat to the Commission?s ?system of securities regulation?, which is the stated objective in the Commission?s statement accompanying the proposed amendment. 6. Subpart (B) of the proposed new definition also provides that improper professional conduct would include ?an unreasonable violation of applicable professional standards that presents a substantial risk, which is either known or should have been known, of making a document prepared pursuant to the federal securities laws materially misleading . . . .? This language allows so much leeway that it virtually swallows any other more limiting language in the proposed amendment. To require a showing of ?an unreasonable violation? fails to set a clear limit. Nor does the limitation requiring ?a substantial risk . . . of making a document prepared pursuant to the federal securities laws materially mislead? add significant limits. Moreover, the proposed language does not even require a showing that the respondent accountant actually knew of the risk; it is sufficient if there is a finding that the accountant ?should have known.? We can easily envision the Commission?s staff arguing that such a risk is almost always present when there is any arguable departure from professional standards. Indeed, we believe that a threshold requirement for any finding of ?improper professional conduct? should include a determination that there has been a materially false or misleading statement in a document filed as required by law with the Commission. The inclusion of the proposed language in Subpart (B) prevents the proposal from achieving significantly more in the way of clarity than is present under the current Rule that has been so severely criticized by federal courts. 7. When the Commission considers the whole subject of Rule 102(e), it is important to keep in mind that both generally accepted accounting principles and generally accepted auditing standards are not like cookbook recipes, where reading words and following directions results in a uniform outcome. Resolution of many auditing and accounting issues requires judgment. Even where there is written guidance, there is often ambiguity. The accountant must attempt to synthesize practice and different pronouncements that may speak ambiguously or indirectly to the issue and that may have changed over time. What the proposed amendment labels as a ?violation of professional standards? is apt to be, in practice, a difference of opinion between the Commission?s staff and the respondent accountant over how a particular pronouncement or pronouncements should be applied. 8. With the foregoing principles in mind we suggest that the Commission substitute for its proposed amendment the following definition of ?improper professional conduct?: (a) conduct which is an intentional or knowing violation, including an equivalent reckless violation, of GAAP or GAAS and the Commission?s rules and regulations relating to financial reporting; (b) a course or pattern of unreasonable conduct showing repeated failure to conform to GAAP or GAAS or the Commission?s rules and regulations relating to financial reporting which demonstrates that the accountant lacks competence to practice before the Commission and where such lack of competence constitutes a future threat to the integrity of the Commission?s processes and to its administration of the federal securities laws; or (c) highly unreasonable conduct violating GAAP or GAAS or the Commission?s rules and regulations relating to financial reporting which demonstrates that the accountant lacks competence to practice before the Commission, where the conduct has resulted in a material misstatement of financial statements of a registrant and where such lack of competence constitutes a future threat to the integrity of the Commission?s processes and to its administration of the federal securities laws. 9. The proposed amendment should also provide that the phrase ?highly unreasonable conduct? requires proof by clear and convincing evidence that the accountant failed to perform a clearly mandated auditing standard or that the financial statements with which he or she is associated failed to follow a clearly mandated accounting principle. We suggest that the proposed rule also direct that, in determining whether conduct was highly unreasonable, evidence that the accountant reviewed relevant professional literature and utilized available procedures for consulting with others within the accountant?s firm, under circumstances where the accountant knew that the matter under consideration warranted heightened scrutiny, would militate against a finding that the accountant?s judgment was highly unreasonable. We also believe that, in the statement accompanying any proposed rule, the Commission should make absolutely clear that in applying all aspects of the Rule, conduct should be judged on the basis of information available to the accountant at the time the accountant acted, and not on the basis of hindsight. We appreciate the opportunity to submit these comments and would be glad to answer any questions the Commission or its professional staff may have about them. Respectfully, PricewaterhouseCoopers LLP