When KPMG audit partner Scott I. London accepted an envelope of cash from his golf buddy in the parking lot of Starbucks, he had no idea that the FBI was photographing and recording the transaction. Nor did he have any idea that his friend, who had been caught by the FBI trading on the inside information provided by London, was now acting at the direction of the FBI in making a criminal case against London.
London was a senior partner at KPMG in Los Angeles, in charge of KPMG’s audit services practices for KPMG’s Pacific Southwest region, which included Southern California, Arizona and Nevada. See Criminal Complaint, United States v. Scott I. London, 13-1058M (C.D. Cal. April 11, 2013) (“Criminal Complaint”) at 2-3. London was a licensed CPA and had worked at KPMG for nearly 30 years, where he supervised approximately 53 audit partners and hundreds of CPAs at the firm. Id. at 23; Complaint, SEC v. Scott London and Bryan Shaw, CV 13-2558 (C.D. Cal. April 11, 2013) (“SEC Complaint”) at 3. In his role as audit partner, London personally handled and supervised audits for major KPMG clients, including Herbalife Ltd., Skechers, RSC Holdings, Pacific Capital Bancorp, and Deckers Outdoor – all of whose shares were publicly traded on either the NYSE or NASDAQ. Because London handled and supervised the audits of these companies, he had access to material non-public information about each company before that information was disclosed to the investing public.
According to the government, London disclosed confidential information about these KPMG clients to Bryan Shaw. London met Shaw at a country club and spent time playing golf and socializing with him. SEC Complaint at 5. The inside information included specific details about earnings that were about to be released in earnings statements, as well as details about impending mergers. London also provided advice to Shaw on how to structure the purchases of securities in order to avoid detection. In exchange for the inside information, Shaw gave London thousands of dollars in cash, jewelry, and concert tickets. Shaw made approximately $1 million on the trades from the inside information, and London received a total of approximately $50,000 in exchange. See Criminal Complaint at 3, 13, 23.
After a visit from the FBI and an interview with the United States Attorney’s Office, London informed KPMG that he was under criminal investigation for insider trading. KPMG promptly terminated London and issued a press release on April 11, 2013 by KPMG Chairman & CEO, John Veihmeyer, stating that “[London] violated the firm’s rigorous policies and protections, betrayed the trust of clients as well as colleagues, and acted with deliberate disregard for KPMG’s longstanding culture of professionalism and integrity.” Indeed, London himself stated that “KPMG had nothing to do with what I did. The firm bears no responsibility in this matter.” [SEC Complaint, Appendix A.] In spite of KPMG’s lack of culpability, however, the firm concluded that it had to resign as independent auditor for Herbalife and Skechers, and withdraw several years of audit reports for those clients, because the firm’s independence had been impaired as a result of London’s conduct.
What was undoubtedly frustrating to KPMG is that London committed these crimes even though he regularly received ethics training at KPMG that explicitly prohibited employees from disclosing inside information regarding clients. [Criminal Complaint at 23; SEC Complaint at 13.] KPMG’s ethics program appears to include what the SEC requires of brokerage firms and investment advisers, namely, the establishment and enforcement of written policies to prevent the misuse of material nonpublic information by the firm or its associated persons. [See Exchange Act, Section 15(f); Investment Advisers Act, Section 204(A).] The problem is that London was undeterred by KPMG’s policies (and its enforcement of those policies), and KPMG did not detect the fact that its senior audit partner in charge of an entire geographic area was engaging in insider trading.
Public company accounting firms, like broker-dealers and investment advisers, have to continually improve compliance systems in order to prevent and detect insider trading and avoid the adverse consequences that befell KPMG. A few ways public accounting firms can work to deter this conduct and promote compliance include the following.
Tone From the Top
Senior management must continually reinforce the message that disclosing non-public material information will result in termination and loss of licensure. This message must be articulated clearly and frequently, and the tone of the message must be unapologetic and uncompromising.
Education and Training
Meaningful training should not come from a video or from the Human Resources department. Training should come from a combination of senior management, an outside vendor, and even law enforcement. There is nothing more likely to deter misconduct than learning about the consequences of insider trading from a federal law enforcement agent. Effective compliance training requires getting the employees’ attention, and nothing does that better than an agent with a gun. Law enforcement officials are often willing to speak to the employees of a company or firm if they believe it will foster compliance.
Need-to-Know Basis
Sensitive information should be disclosed to employees only on a need-to-know basis. Applying this rule serves two purposes: it limits the number of employees who have the inside information, and thereby decreases the risk of insider trading; and it narrows the number of employees to investigate in the event that there is evidence of insider trading.
Surveillance
A firm should perform surveillance of email and other communications relating to impending events about public companies that the employees are privy to because of their position at the firm. The firm should also make all employees aware of the existence of the surveillance, which will further serve to deter inappropriate communications.
Red flags
Even if a firm has robust surveillance systems, an employee intent on revealing insider information will find a way around the firm’s controls. Accordingly, any behavior that seems even slightly anomalous should not be ignored. For example, if an employee is frequently excusing himself or closing his office door to speak on his cell phone in the days just prior to public announcements relating to public company clients, such conduct should be investigated.
Whistleblower Hotline
Public accounting firms should establish a hotline to allow employees to report suspicious behavior, even if anonymously. The existence and advertisement of a hotline will not only provide the firm with more “eyes and ears,” but will also help deter employees from engaging in wrongdoing.
The London case reinforces the stark reality that public accounting firms continually face a significant risk that their employees, who are often privy to highly valuable inside information, will jeopardize the engagements they work on, and will tarnish reputation of the firm. Although no compliance program can completely eliminate this risk, a robust program can greatly mitigate the danger and more importantly, can reduce the risk that a regulator or law enforcement agent will turn its investigative focus on the accounting firm itself.
Amy Walsh is a partner at Kostelanetz & Fink LLP. Ms. Walsh was formerly an Assistant United States Attorney in the Eastern District of New York for 11 years, where she was the Chief of the Business & Securities Fraud Section.
Comments powered by CComment