Why KPMG won’t be suing Scott London

After the sentencing of Scott London to 14 months in prison, KPMG issued me (and the rest of the world) a statement saying:

It was appropriate that Scott London was held accountable for the consequence of his illegal and unethical action.

As I mentioned earlier, there were some comments in public by Mr. London’s attorney that KPMG and Mr. London had worked out something through the partnership agreement. My guess is they closed out his capital account.

My guess at the time was that the sentencing cleared the path for KPMG to sue Mr. London. They would definitely have cause since the Herbalife reaudit cost around $15M, and they probably sent the bill to KPMG, who probably paid it quickly. I’ll guess that KPMG paid for the reaudit of the other two clients.

So, will KPMG sue Mr. London?

When I tweeted about my post, Francine McKenna followed up with a tweet saying something to the effect that this was the end of the case. Nothing else would be heard.

I recently visited with Ms. McKenna. She explained why she didn’t think there would be any lawsuit. She gave me permission to share her reasons.

She thinks KPMG will not pursue any litigation against Mr. London because they don’t want any more publicity. The criminal case is settled. Mr. London will be reporting to prison next month. The visibility of the case has dropped off the radar screen. Other than this teeny tiny blog and an upcoming CPE session next Wednesday, 6/25 – lots more about that soon.

So, the first major reason for no suit – avoid creating more publicity.

The very visible criminal prosecution and investigation by the feds and KPMG has shown clearly there weren’t any other staff involved. A boundary has been set around the number of companies involved.

There is a clear separation between KPMG and Mr. London’s actions.

The Thomas Flanagan case with Deliotte is quite different. Mr. Flanagan was a vice chairman of Deliotte LLP who was sentenced to prison for 21 months for insider trading. Ms. McKenna described to me in that situation, Deliotte had to sue Mr. Flanagan to show there was separation between him and the firm. In the London & KPMG situation, the feds had already researched the issue, put a boundary around the persons involved and companies traded , and resolved the case. All that happened before KPMG knew there was an issue. Thus, KPMG doesn’t need to establish distance.

Unlike Mr. London who passed tips to his golf buddy, Mr. Flanagan personally traded on the inside information.

Here is some additional info on Mr. Flanagan’s incarceration:

He was sentenced to 21 months in federal prison, as reported by Bloomberg on 10/26/12. He was also given one year supervised release and a $100,000 fine. A reporting date 60 days after sentencing would give an estimated incarceration date of about 12/26/12.

The Bureau of Prisons’ inmate locator service shows Thomas P Flanagan (Register Number: 44822-424, age 66) has a release date of 7/23/14. That release date would be about 64 days short of 21 months after the estimated reporting date. That would in turn be consistent with the 53 days credit for good time that I’ve read is available for each year in federal prison.

The BOP site says his location is the Chicago Residential Reentry Management facility. That means he is out of federal prison. He is either home under supervision by the Chicago RRM or he is residing at the Chicago RRM facility.

Back to KPMG and Mr. London…

So, the second reason we won’t see any litigation –  KPMG is disassociated from the inside trading mess.

Finally, it is possible there could be something else involved. Ms. McKenna doesn’t know what it could be, but there is a possibility there might be something else. Perhaps another client. Perhaps a different staff person doing something on the periphery. Perhaps something unrelated that’s embarrassing to the firm but might surface during trial.

Perhaps KPMG just doesn’t want to risk arousing any sleeping dogs that nobody knows are still sleeping.

So, the third reason for no litigation – keep unknown issues unknown.

I will add another reason – it’s probably not worth the effort financially.

How much could KPMG recover? They already grabbed whatever is in the retirement/capital account, which I will guess is several million and is probably the bulk of any Big 4 partner’s net worth. How much more could there be? A commenter on my blog points to a vineyard that is owned by Mr. London’s wife. As a wild guess, there could be a couple of houses for investment purposes. What could that all add up to? A million? 3? 5?

There is the issue of an unknown amount of legal fees for the initial investigation, negotiations with 3 audit clients, and negotiations with Mr. London regarding his capital account.  Those would be premium fees since the big firms draw on the best law firms who charge proportionate fees. Any guesses on how much that might be? Quarter of a million? Half? Full million?

Oh, and filing a lawsuit would require having all the documents, exhibits, and filings ready to go before giving anything to the clerk of the court. How much would that be? Another hundred grand? Quarter million?

Here’s the string of my guesses on the overall financial picture:  KPMG is out $15M spent on reimbursing Herbalife, plus several more million on the other two reaudits,  plus the unknown amount of legal fees already incurred, plus legal fees to file a suit, less a million or two or three reimbursement from the retirement/capital account, which leaves the firm out something in the range of $12M to $18M. My wild guess of a potential recovery is maybe $1M to $4M. Taking the low/high and high/low of those wild guesses gives a possible net loss position after litigation recovery of something in the range of $8M to $17M.  There is still a substantial loss even with successful litigation recovery.

My guess? The potential recovery of a few million is a huge number to you and me, but in the overall scheme of a Big 4 firm, that is probably in the range of write-off authority for a regional partner. Might be worth giving up on a recovery just to never again see this case mentioned in the Wall Street Journal. Might be worth it so no internal KPMG staff or partners ever have to deal with it again.

The firm will let it go. The potential payoff isn’t significant. That amount, whatever it might be,  is more than offset by the known risk of new publicity and unknown risk of sleeping dogs racing around the courtroom.

The fourth reason for no litigation – not worth it financially.

Full disclosure:  A long time ago I worked at Peat, Marwick, Mitchell for three years in their Albuquerque office. PMM was the predecessor to KPMG. I am a sole practitioner providing audits and reviews to the nonprofit community. Filter my comments as you wish.

What do you think?

Any thoughts? Did I miss the boat?  Want to revise my estimates? Can you provide better guesses for any of the numbers?

Comments welcome. (Keep it professional!)