Independence and Integrity Compromised by Insider Trading
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I have previously blogged about the case of Scott London, an audit partner at KPMG who traded on inside information and violated the accounting profession’s most sacred ethical standard of audit independence. London was convicted of leaking confidential information to his friend, Brian Shaw, about Deckers, Pacific Capital Bancorp, Skechers, and Herbalife – all audit clients of KPMG. The leak of information about quarterly earnings information led to Shaw’s unjust enrichment of $1.27 million. Shaw, a jewelry store owner and country club friend of London, repaid London with $50,000 in cash and a Rolex watch, according to legal filings.
London settled administrative proceedings with the Securities and Exchange Commission that includes SEC sanctions and forfeiture of the right to appear or practice before the SEC as an accountant. On the criminal side, the federal prosecutir in the case has asked for a three-year prison sentence for his insider-trading conviction for selling secret information about the accounting firm's clients to Shaw. London is scheduled to be sentenced on April 24.
I am happy to report that the California Board of Accountancy completed its investigation of London and issued an order effective December 27, 2013, that required him to surrender his CPA license and pay costs of investigation and prosecution in the amount of $1,637.50.
As for KPMG, the firm withdrew its audit opinion on Skechers and Herbalife. The firm released a statement that should raise red flags for all CPA firms that audit public companies. The firm stated it had concluded it was not independentbecause of alleged insider trading. This is a weak statement at best and illustrates the moral blindness of some public accounting firms that do not seem to realize they are at fault for the actions of auditors with respect to the use of inside information. London’s actions were dishonest, lacked integrity, and compromised the public’s trust in him as a CPA and in KPMG.
This case is a particularly egregious one for the audit profession because it involves insider trading by an auditor of client stock. The violation cuts to the basic core of what it means to represent the public interest, not one’s own self-interest or the interest of a client. Auditors must not only be independent in fact, a violation in the Scott London case, but also appear to be independent. How can an auditor expect the public perception to be he is independent when he gives inside information about a client to a friend who trades on that information and, what’s worse, accepts gifts in return?
Public accounting firms have an ethical obligation to monitor the actions of its partners, managers, and staff that may impair audit independence. One test of whether independence exists is to assess whether any threats to independence are present and, if so, whether safeguards exist to mitigate those threats. The failure in this instance of KPMG is in its lack of quality controls to prevent and detect violations of basic ethical standards by adequately evaluating these issues.
I am concerned about increasing instances of insider trading by accounting professionals. The leaking of financial information about a company to anyone prior to its public release affects the level playing field that should exist with respect to personal and business contacts of the leaker and the general public. It violates the fairness doctrine in treating equals, equally, and it violates basic integrity standards. The KPMG scandal concerns me because it may reflect a pattern of such improprieties.
In 2010, Deloitte and Touche was investigated by the SEC for repeated insider trading by Thomas P. Flanagan, a former management advisory partner and a Vice Chairman at Deloitte. Flanagan traded in the securities of multiple Deloitte clients on the basis of inside information that he learned through his duties at the firm. The inside information concerned market moving events such as earnings results, revisions to earnings guidance, sales figures and cost cutting, and an acquisition. Flanagan’s illegal trading resulted in profits of more than $430,000. In the SEC action, Flanagan was sentenced to 21 months in prison after he pleaded guilty to securities fraud. Flanagan also tipped his son, Patrick, to certain of this material non-public information. Patrick then traded based on that information. His illegal trading resulted in profits of more than $57,000.
Instances of insider trading by accounting professionals is troublesome because it continues the slide down the proverbial ethical slippery slope in accounting that began in the 1960s and 1970s when commercialization in the profession crowded out professionalism. Changes in the rules that now permit accepting commissions and contingent fees, in non-audit situations, and advertising and soliciting clients with minimal safeguards started the descent.
I hope the profession learns its lesson from these insider trading cases and, going forward, it does a better job of monitoring the personal activities of audit, tax and advisory services partners, managers, and staff that could compromise independence and integrity so that it can live up to its public interest ideal that makes accounting a profession, not just an occupation.
Blog posted by Steven Mintz, aka Ethics Sage, on April 23, 2014