More on KPMG and the Precedents for Possible Punishment

My WSJ colleagues Dave Michaels and Michael Rapoport followed up on last week’s KPMG – PCAOB inspection leak scoop with a profile of the disgraced partner in charge of the firm’s U.S. audit practice, Scott Marcello.

Michaels and Rapoport ask the question on everyone’s mind—at least since the last time a high-level KPMG audit partner also named Scott disgraced himself and the firm:


How Did Scott Marcello Fall From Grace?


(KPMG did not sue Scott London for dragging its name through the mud and causing two of its clients to drop the firm. I seriously doubt KPMG will sue anyone for this. They made that mistake once before and will never make it again.)

Marcello, say Michaels and Rapoport, is a three-decade veteran of the firm, “highly regarded and technically accomplished”, who specialized in “the intricate financial statements of banks and insurers.” Marcello “climbed the ladder,” succeeding the previous KPMG vice chair of audit, James P. Liddy, in July of 2015.

(Marcello has probably been a bit too preoccupied to update his LinkedIn profile. It still shows him as currently employed. Liddy’s LinkedIn says he is still the regional head of audit for the Americas and also a vice chair.)

Marcello was “straight out of central casting,” said an anonymous source who had worked with him that was quoted by the reporters. He was “the exact opposite of flashy,” the person told the WSJ.

Marcello, and a deputy named David Middendorf, were fired for their roles in the scandal along with three others and a staff person, according to a statement from KPMG. However, the exact roles everyone is alleged to have played in the illegal receipt and use of confidential regulatory information governed by federal securities laws are still unclear.

KPMG’s statement did say Marcello and Middendorf were aware that others at KPMG had received leaked information and “failed to report the situation in a timely manner.”

Middendorf was also “a star at the firm” according to the WSJ. He led audits of Home Depot Inc., J.C. Penney Co. and Macy’s Inc. before becoming national managing partner of audit quality. He was directly responsible for dealing with the PCAOB. Neither Marcello or Middendorf are reported to have led any audits directly in 2016, according to a new PCAOB database that is populated by the firms submissions after the annual reporting season. Middendorf was also a PCAOB Standing Advisory Group member.

The WSJ article comes to no conclusions about Marcello and Middendorf’s motivations for dropping a megaton bomb on their careers and reputations. I have a theory about that and will share in a future post.

The rest of the people involved in the scandal remain unnamed.

The WSJ article does not speculate about the civil, criminal or professional penalties that may be imposed in the case by the SEC, PCAOB or the Department of Justice.

If you are surprised by my mention of potential criminal penalties you should not be. This case mirrors the 2014 case where in 2014 a junior Federal Reserve Bank of New York employee leaked “a regulatory gold mine,” according to a New York Times article, to a junior Goldman employee who was a former New York Fed employee himself.

What are they teaching—or not teaching— in the universities these days?

According to a NY Times report, the Fed said the confidential information stolen included reports of bank examinations and other “confidential reports prepared by banking regulators.” Goldman Sachs, the Fed said, illegally used the information in presentations to current and prospective clients “in an effort to solicit business.”

Goldman Sachs, like KPMG, not the New York Fed, or the PCAOB in this case, uncovered the leak. Goldman fired the recipient of the leaked info and an executive who supervised him who they said had “failed to properly escalate” the problem. The New York Fed fired the leaker employee and notified law enforcement agencies.

Rohit Bansal, the Goldman Sachs employee who prosecutors say instigated the theft by his friend Jason Gross, the NY Fed employee, pleaded guilty to a misdemeanor for obtaining about 35 documents on about 20 occasions from his partner in crime. Bansal escaped a jail sentence but was sentenced to two years probation, 300 hours of community service and a $5,000 fine. Gross pleaded guilty to a misdemeanor and was sentenced to a year’s probation.

Goldman paid a $50 million penalty to New York State regulators because its “management failed to effectively supervise” and paid another $36.3 million to the Federal Reserve Board, the central bank authority, because it is “illegal to use or disclose confidential supervisory information without prior approval.”

Joseph Jiampietro, the former managing director at Goldman Sachs’ investment banking division and Bansal’s supervisor, sued Goldman Sachs for failing to pay at least $350,000 in legal fees he incurred defending himself.

Readers may recall KPMG was also sued by its partners for not covering legal fees accumulated in their defense of allegations related to KPMG’s settlement with the DOJ for tax shelter fraud in 2005.

“KPMG LLP, anticipating criminal charges would be a “nuclear bomb” that would wipe out the accounting firm, pleaded with federal officials in 2005 not to indict it for selling fraudulent tax shelters, newly released internal documents show. Expecting the worst, KPMG partners sought advice from bankruptcy lawyers, the internal documents show. The firm’s attorneys told prosecutors that KPMG’s demise would disrupt capital markets, leaving more than 1,000 companies without an auditor.

The argument was dismissed as “ridiculous” by David Kelley, the U.S. attorney in New York in charge of the case. “You are not the only firm in trouble and not just from criminal exposure,” Kelley said, according to the memos. “The industry is going to crap.”

…In the end, the documents reveal, the U.S. Justice Department’s top two officials interceded, and KPMG avoided the fate of Arthur Andersen LLP …The papers came to light only because of a related criminal case against 18 individuals, mostly former KPMG employees. They are asking U.S. District Judge Lewis Kaplan to throw out the charges on grounds the government violated their constitutional rights by pressuring KPMG to cut off legal support for the former employees. Kaplan will hold a hearing on the issue July 2 in federal court in Manhattan.

The judge eventually dismissed charges against 13 defendants in the case because their Constitutional rights had been violated.

In a hearing before the Senate Judiciary Committee on September 12, 2006, “The Thompson Memorandum’s Effect on the Right to Counsel in Corporate Investigations”,  Paul McNulty, who was then the United States Attorney for Eastern District of Virginia, testified that:

Judge Lewis Kaplan of the United States District Court for the Southern District of New York framed the issue well in his written opinions this summer delivering two important rulings in United States v. Stein et al., a case involving the Justice Department’s investigation and prosecution of KPMG’s now-admitted tax-shelter abuses. At the outset of the first of Judge Kaplan’s two opinions finding that the Thompson Memorandum, coupled with the specific conduct of the federal prosecutors, violated the Fifth and Sixth Amendment rights of twelve former KPMG employees, he addressed the fundamental duties of the government whenever it exercises its law enforcement power.

Those who commit crimes – regardless of whether they wear white or blue collars – must be brought to justice. The government, however, has let its zeal get in the way of its judgment. It has violated the Constitution it is sworn to defend.

When an individual’s constitutional rights are implicated, the government may not do indirectly –through others – what it is forbidden to do directly. The Constitution would not have allowed the prosecutors in the Stein case to, for example, subject the KPMG defendants’ bank accounts to forfeiture with the sole justification and for the sole purpose of depriving them of the money they needed to retain competent legal counsel. The Constitution would not allow the prosecutors to threaten the KPMG defendants with the loss of employment if they refused to proffer testimony during the investigation or invoked their Fifth Amendment rights.

Instead of accomplishing these ends directly, Judge Kaplan found that the prosecutors made keen use of the enormous pressure placed upon KPMG by the existence of the Thompson Memorandum and the realities of what a federal indictment may mean to a financial
services firm. The indictment and swift demise of the Arthur Andersen accounting firm has taught every business organization a stern
lesson: Failure to meet federal prosecutors’ expectations for your cooperation in the government’s criminal investigation of your employees could result in a death sentence, well before a jury is ever impaneled or opening statements are delivered at trial.