Case Study10 Scott London was a senior partner at KPMG in charge of the audit practice for clients in California, Arizona, and Nevada. He also personally oversaw audits of Herbalife and Skechers. He worked at KPMG for thirty years. Over a two-year period, he passed the information on several companies by reading his friend, Brian Shaw, news releases before they were issued, telling him about planned acquisitions, and giving him advance word about earnings that were not yet public. That allowed Shaw to make many profitable trades. For example, Shaw purchased thousands of Herbalife shares in the weeks before an announcement of the company's record sales. The announcement sent Herbalife shares up 13%, and Shaw made a profit of about $450,000. Shaw was also told that another KPMG client, Pacific Capital Bancorp, was about to be acquired by Union Bank. Pacific Capital's shares increased 57% when the news was announced and Shaw made $365,000. Regulators became suspicious of Shaw's well-timed trades and began an investigation. The regulators had Shaw secretly record conversations with London and were filmed by the FBI handing London an envelope of cash. Shaw pleaded guilty to conspiracy to commit insider trading. KPMG fired London and withdrew several audits of Herbalife and footwear maker Skechers, plus resigned as the auditor of both clients. A criminal case was filed a few days later. At the trial, London said he was helping a friend whose jewelry business was in financial trouble, thinking regulators would not look at the "small fish." London believed Shaw made about $200,000 on the trades when, in fact, it was over $1.2 million. He also admitted to receiving $60,000 in cash and a $12,000 Rolex watch, part of which was on the FBI film. Compared to the earnings he made as a very senior audit partner in a major accounting firm, this was insignificant. London was sentenced to fourteen months in prison (it could have been up to twenty years) and charged with civil penalties -not to mention the legal fees and damage to his reputation.

Case Study Question Do you believe that it was necessary for KPMG to retract their opinion on the audits London was in charge of? How about resigning as the auditor?