Early Returns: Scott London, KPMG and Another Partner Trading On Inside Information

I’m working today on an update to the Scott London insider trading story. Scott London is the KPMG Southern California Regional Audit Partner in Charge who faces charges by the SEC and Department of Justice  – civil and criminal – for passing inside information on five clients including Herbalife and Skechers to a third party.

I was in Texas last week, visiting Texas A&M and speaking at the IIA Houston Annual Conference, so this news could not have broken at a better – and a worse – time. It’s difficult to keep up on a breaking story like this when you already have 24/7 commitments. I was driving to College Station Monday night after speaking at the IIA Conference while the news was breaking. First thing I did when I arrived is go to dinner with some faculty. When I got back in the hotel room I read all the media reports of KPMG’s press release about the partner’s violations of client confidentiality, firm policy and, possibly, federal laws.

By morning there was a feeding frenzy to find out who the partner was – not too hard since KPMG gave his title and responsibilities – and the two audit clients that KPMG said that had resigned from.

I had a quick breakfast with Professor Mike Shaub of Texas A&M and we speculated that all the names would be public by the time we met for class at 11 am CST.

That’s what happened. There’s nothing better than to have a live, tangible scandal to illustrate what I was going to talk about for two day in Professor Shaub’s Accounting and Ethics class.  (More on that in a separate post.)

I wrote a column for Forbes on Wednesday morning before starting my day with the Aggies.

That column, Another ‘Rogue’ Audit Partner; Another ‘Duped’ Audit Firm, focuses on a pattern that is developing for these cases and the number of them in the recent past. It’s amazing to see one publication saying audit partner illegal acts are rare and another saying it happens some times. This is the fourth big case in the least few years against a senior tenured partner that betrayed the public’s trust. In none of the cases did the firm’s “extensive” and “comprehensive” independence compliance programs spot the behavior or the illegal actions.

Deloitte wasn’t the one who discovered that its Vice Chairman and Chicago charity circuit regular Tom Flanagan was trading on the inside information of several Fortune 500 companies including Berkshire Hathaway. In that case it was FINRA, the securities self-regulatory organization, that saw trading activity by an audit firm partner in a company with M&A activity.

When Deloitte tax partner Arnie McClellan’s wife “eavesdropped” on her husband’s phone calls where he discussed his client’s M&A targets and then called her sister in London, Deloitte didn’t know until London authorities called. McClellan’s wife said her husband was innocent and everyone believed her. She did serve time for initially lying about her own involvement.

It wasn’t Ernst & Young that uncovered tax partner James Gansman passing M&A tips to his lover who, in turn, passed them to hers. Gansman’s “swinging” partner ended up on an SEC watch list and Gansmen went to jail based on her testimony against him. He did not profit from his breach of client confidentiality other than in ways some men might prefer to the discounted watch, dinners, and few thousand dollars Scott London, the KPMG partner we heard about yesterday, says he received.

Surely more information will come out over the next few week, from KPMG, from additional  companies affected and from the media, who will pursue this story like pit bulls. One reporter who emailed me yesterday said these stories of have “legs”. Hubris, and stupidity in unexpected places, are great media fodder.

KPMG said in its press release that the firm resigned as auditor from two of London’s clients, Herbalifeand Skechers, although it did not name them. He was the top partner on those audits. The time and money those companies will have to spend to appoint a new auditor, re-audit years of financial statements and fend off media attention will probably be subsidized, one-way or another, by KPMG. In the Flanagan case, Deloitte paid for the necessary independent investigations to support the firm’s claim to clients that it was still independent as an auditor. None of them – Berkshire Hathaway, Walgreens, Sears Holdings among the victims – fired the firm.

The SEC and PCAOB did not fine or sanction Deloitte or Ernst & Young in any of the cases.

It’s no wonder then they can’t spot fraud in their clients…

KPMG was proactive, at least compared to Deloitte and Ernst & Young which hid under a rock on the Flanagan, McClellan and Gansman cases respectively, in issuing a statement to kick the whole reporting derby off on Monday night. London did not trade on the information like Tom Flanagan at Deloitte but the amount of national and international media attention is much much higher. That’s undoubtedly attributable to the involvement of Herbalife. Initial speculation centered on whether London had passed tips to one of the hedge funds involved in the contentious public battle over the company’s business model.

I speculated that there were more clients affected than just the two KPMG quit from. I also said London’s tippee was most likely a jeweler.

But surely Scott London, KPMG’s “rogue”, had access to confidential information about more clients of the firm than just the ones he was directly responsible for. He was the partner in charge of the audit practice for a huge market, Los Angeles. He has the right, and the responsibility, to know about every interesting or problematic thing going on at the audit clients in his practice group.  He may be a “concurring” or quality review partner on more companies’ audits and can “drop by” audit committee and other client meetings on a relationship-building basis. The exposure to KPMG and to the clients of this practice unit, and perhaps others, may be larger than what’s been admitted by the firm so far.

Scott London is making statements to the press. He’s wealthy enough to afford a lawyer and PR – but obviously not wealthy enough to resist the temptation ofa “discount” on a watch and a few bucks. (London didn’t even get a watch. He got a discount. Looking for the tippee? Go look for a prominent LA jeweler in financial trouble who’s too cheap to pay well for stealing a man’s career, professional reputation and, possibly, his freedom.)

Late on Thursday while I was sitting at Houston airport waiting through a three-and-a-half hour delay, KPMG issued another press release announcing its disgust with the additional clients and sordid details included in the SEC and DOJ complaints. There were more clients affected and the tipped was a jeweler.  KPMG  also said it would sue London. I was not surprised. I wrote late Thursday night:

Deloitte also brought swift legal action against former Vice Chairman Tom Flanagan over insider trading charges. That case did not result in any client loss for Deloitte. If KPMG’s suit is anything like Deloitte’s it will list even more allegations than the SEC and Department of Justice. KPMG will investigate fully to justify recovery of any costs incurred to assuage audit clients and to deny London’s retirement benefits.

Stay tuned. There will be much more to this story, I guarantee. Jim Ulvog, a CPA firm owner in California, is on the job tracking coverage and giving us his views on the personal side to the story.  No one yet can really answer, “Why did he do it?”

From Jim Ulvog:

Background articles emerging on KPMG insider trading fiasco

Failing the front-page-of-The-Wall-Street-Journal test twice in one week

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