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Ross v. Securities and Exchange Commission

decided: May 10, 1979.


Before Kaufman, Chief Judge, and Timbers and Gurfein, Circuit Judges.

Author: Timbers

One of the most urgent problems of our day is the responsibility of the courts and other government bodies to prescribe high standards of conduct for their members and for those who practice before them. An indispensable corollary of this responsibility is the right indeed, the duty to discipline those who fail to conform to the high standards of conduct which have been prescribed.

We are called upon today to determine (1) whether the Securities and Exchange Commission ("SEC" or "Commission"), pursuant to one of its Rules of Practice which has been in effect for more than forty years, may conduct an administrative proceeding to determine whether certain professionals in this case, accountants should be censured or suspended from appearing or practicing before the Commission because of alleged unethical, unprofessional or fraudulent conduct in their audits of the financial statements of two corporations; and (2) if the Commission is authorized to conduct such an administrative proceeding, whether it should be permitted to conclude it before the accountants resort to the courts. For the reasons below, we hold that both questions must be answered in the affirmative.


On September 1, 1976 more than two and one-half years ago the SEC, pursuant to Rule 2(e) of its Rules of Practice, 17 C.F.R. § 201.2(e) (1978),*fn1 entered an order*fn2 which provided for a public administrative proceeding against the accounting firm of Touche Ross & Co. and three of its former partners, Edwin Heft, James M. Lynch and Armin J. Frankel. The firm and the three partners, all appellants, will be referred to collectively as "Touche Ross" or "appellants".

The proceeding was instituted to determine whether appellants had engaged in unethical, unprofessional or fraudulent conduct in their audits of the financial statements of Giant Stores Corporation and Ampex Corporation.*fn3

The Commission's order alleged that Touche Ross and the individual appellants, in examining the companies' financial statements, had failed to follow generally accepted accounting standards and had no reasonable basis for their opinions regarding the financial statements of these companies. The order also recited that, if these allegations were found to be true, they tended to show that Touche Ross and the individual appellants had engaged in improper professional conduct and willfully had violated, and had aided and abetted violations of, §§ 5, 7, 10 and 17(a) of the Securities Act of 1933*fn4 and §§ 10(b) and 13 of the Securities Exchange Act of 1934,*fn5 and rules and regulations thereunder.

In view of the nationwide accounting practice of Touche Ross,*fn6 the SEC decided that it would be in the public interest to institute a public proceeding and to order a hearing at which Touche Ross would be afforded an opportunity to present a defense to these charges.*fn7 The Commission then would have been in a position to determine whether the substantive allegations were true and, if so, whether Touche Ross and the individual appellants should be disqualified, either temporarily or permanently, from appearing and practicing before the Commission.

No administrative hearings have ever been held in this case.

On October 12, 1976, Touche Ross commenced the instant action for declaratory and injunctive relief in the Southern District of New York, naming as defendants the Commission and four of its members in their official capacities. By this action, Touche Ross sought a permanent injunction against the on-going administrative proceeding which had been instituted against them by the SEC pursuant to Rule 2(e). Touche Ross also sought a declaratory judgment that Rule 2(e) had been promulgated "without any statutory authority"; that the Rule 2(e) administrative proceeding had been instituted against them "without authority of law"; and, in any event, since the SEC does not constitute an impartial forum for the adjudication of the issues raised in the SEC's Rule 2(e) order, that such administrative proceedings would deny Touche Ross due process of law.

The SEC moved to dismiss the complaint pursuant to Fed.R.Civ.P. 12(b)(6) and 12(b)(1) on the grounds that Touche Ross' complaint failed to state a claim upon which relief could be granted and that the court lacked subject matter jurisdiction over the asserted claims for relief. The crux of the SEC's position in support of its motion to dismiss was that Touche Ross improperly had failed to exhaust administrative remedies.

After a hearing, the district court, Constance B. Motley, District Judge, filed a well-reasoned opinion granting the SEC's motion and ordering that the action be dismissed. (1978 Transfer Binder) Fed.Sec.L.Rep. (CCH) P 96,415 (S.D.N.Y. April 24, 1978). The district court rested its decision on the failure of Touche Ross to exhaust its administrative remedies. It did not reach the substantive question of the validity of Rule 2(e).*fn8

From the judgment entered on the district court opinion, this appeal has been taken.


In the light of these facts and prior proceedings, we turn first to the question whether appellants must exhaust their administrative remedies before resorting to the courts to assert their claims.

In order to avoid confusion, we distinguish among three possible situations in the context of the instant case where the exhaustion issue arises: (1) when a litigant, such as Touche Ross, seeks to challenge a final Commission decision and order pursuant to Rule 2(e) which imposes sanctions or disciplines professionals for improper or unprofessional conduct; (2) when a litigant, such as Touche Ross, seeks judicial review of claims of agency bias; and (3) when, as in the particular circumstances of this case, Touche Ross requests this Court to adjudicate the question whether the Commission has the Authority to promulgate Rule 2(e) and to proceed thereunder. With respect to claims (1) and (2), we agree with the district court that Touche Ross must first exhaust their administrative remedies before challenging a Commission determination on the merits, or raising claims of agency bias. With respect to claim (3), however, because there is no need for further agency action to enable us to reach the merits of appellants' challenge to the Commission's authority to promulgate Rule 2(e), we hold, with regard to this claim alone, that appellants need not exhaust their administrative remedies.

The doctrine of exhaustion of administrative remedies is concerned mainly with the timing of judicial review. In general, a litigant is required to pursue all of his administrative remedies before he will be permitted to seek judicial relief. The rationale behind the exhaustion doctrine is that a court's refusal to intervene prematurely in the administrative process gives the agency an opportunity to develop factual findings, to apply its expertise to new issues and to exercise its discretionary powers. See McKart v. United States, 395 U.S. 185, 193-94, 23 L. Ed. 2d 194, 89 S. Ct. 1657 (1969). Moreover, "(notions) of administrative autonomy require that the agency be given a chance to discover and correct its own errors" a practice that will protect the integrity of the administrative process and prevent litigants from flouting the agency's procedures. Id. at 195. We emphasize at the outset that normally we will not tolerate the interruption of the administrative process to hear piecemeal appeals of a litigant's claims on the merits. This is exactly what the exhaustion doctrine was designed to prevent. Accordingly, we wish to ...

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