On July 1, 2013, Scott London, a former KPMG audit partner, pleaded guilty to securities fraud. He had been passing information to his friend, Bryan Shaw, over a two-year period ending in 2012.

He told his friend about earnings announcements by Herbalife Ltd and Skecher USA Inc. as well as the planned merger of RCS Holdings with United Rentals and the takeover of Pacific Capital Bankcorp by Union Bank. Overall, Shaw was tipped fourteen times and used that information to make approximately \($1.3\) million in trading profits.

Why would a senior partner knowingly break the rule of confidentiality? Confidentiality is a value at the heart of the accounting profession. London argued that he was merely helping a friend whose jewelry business was in financial trouble.

London had advised him that it was unlikely that he would be caught. Regulators are not looking for “small fish,” he advised his friend. Furthermore, Shaw thought that his golf partner was making small profits on the various tips that he had been given. He speculated that they were around \($200,000\) and was shocked when he learned that they were over \($1\) million. He said that he “about threw up”

when he learned the size of Shaw’s profits.

London contended that he never asked to share in any of the trading profits, although he did receive \($60,000\) in cash and a \($12,000\) Rolex watch from Shaw. Part of the cash payment was captured by a surveillance photo of Shaw and London in a parking lot. But London claimed that these were small gifts from a friend, and the amounts were immaterial relative to London’s remuneration as the KPMG audit partner in charge of the Pacific Southwest region.

The negative consequences of this insider trading were both direct and indirect.

London, who could have been sent to prison for 20 years, was sentenced to 14 months in April 2014.1 Although KPMG was not involved in any wrongdoing, KPMG resigned as the auditor of both Herbalife and Skechers. London had been the partner in charge of both of these audits.

KPMG said that they were reviewing their internal controls and procedures against the release of confidential information.

They announced that their controls were

“safe and effective” but that nevertheless they would be increasing their monitoring and training.

This event renewed the debate concerning the prohibition on insider trading.

Those in favor of no prohibition argue that the stock market is made more efficient more quickly, but, as indicated in the text on page 427, insider trading is not a victimless crime. KPMG would certainly agree.

Questions:-

1. Should an accounting firm have to resign as the auditor of a company when the partner in charge of the audit is convicted of releasing confidential information about that audit client?
2. How can accounting firms ensure that their partners and staff do not release confidential information?