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Consequences – insider trading edition – #4

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Is possible jail the only bad thing on the horizon for a CPA accused of insider trading? Not quite. There’s a long list of bad things within view.

This post will cover one possible consequence: the possibility of being sued by KPMG.

This series of posts is examining the consequences on the horizon for Mr. Scott London, former KPMG partner, as a result of his indictment for allegedly trading on insider information

Previous posts have discussed:

  • Jail time
  • Criminal fines
  • Legal fees for criminal case
  • Civil fines
  • Criminal tax enforcement
  • Publicity
  • Loss of employment
  • Loss of reputation
  • Loss of professional license

Litigation from employer

The chairman and CEO of KPMG sent out a statement last Thursday evening. Let’s just say he is not amused.

You can see the comment in quite a few places. I first read it in Francine McKenna’s article at ForbesKPMG Statement on Scott London Criminal and Civil Charges.

There are two particular items I noticed:

I was appalled to learn of the additional details about Scott London’s extraordinary breach of fiduciary duties to our clients, KPMG and the capital markets.

Early public comments indicated there were two clients involved. The criminal indictment said there were five. Sitting in my little corner of the audit world that was a surprise.

The CEO’s comments above indicate that may have been a surprise to KPMG leadership. Again, I have no idea what happened behind closed doors, but reading between the lines, that comment suggests that Mr. London may have not fully disclosed the extent of his activities to his employer. I’m basing my wild guess on the “additional details” comment. An alternative could be ‘additional details’ could be the brazenness and intentionality that is alleged in the indictment.

Well that’s just a guess on my part. Take a look at this comment, which Ms. McKenna emphasized:

KPMG will be bringing legal actions against London in the near future.

What could that involve?

For the non-CPAs in my audience, let me walk through what that comment means to me.

Remember that KPMG withdrew three years of audit opinions for Herbalife and two years for Sketchers?

That means another audit firm will have to be brought in to re-audit Herbalife for three years and re-audit Sketchers for two years.

That will cost a ton of money. How much?

Michael Rapoport gives a hint in the WSJ, Bad Week for KPMG Could’ve Been Worse:

Herbalife paid KPMG a total of $11.2 million in fees for the firm’s last three years worth of audits; Skechers paid $1.7 million for its 2011 audit and hasn’t yet disclosed its 2012 audit fees.

On one hand, it won’t take three times as long to re-audit three years as it would to audit one year. So there should be some savings from being able to do three sets of compliance tests or three sets of substantive tests all at the same time. You could test three sets of a particular disclosure for not much more time that it would take to test one year. 

A lot of tests will be easier to perform with two year’s hindsight. Two years after the fact it’s really easy to test allowances for losses, whether for inventory, receivables, returns, or warranties.

On the other hand, the risk is far higher than usual for multiple reasons. So that means it could take longer to re-audit three years than to perform the three years initially.

Let’s pull a number out of thin air by making the huge assumption that it will take as much time to re-audit as it did to perform the audits the first time. Let’s also assume the Sketchers audit in 2012 cost as much as 2011.

So, taking the numbers mentioned by Mr. Rapoport, that would suggest the re-audit fees could be something in the range of $14.6 million (11.2 + 1.7 + 1.7).

Those two companies won’t want to eat those costs. Why are they out that money?  Because KPMG as a firm is no longer independent.  The companies will likely look to KPMG to pick up the tab.

Sitting at my tiny little desk in my tiny little corner of the audit world I’m guessing that KPMG can either write a check today to reimburse the companies for those fees or they can write a check after they get sued. With my little bity understanding of risk management, seems to me KPMG would be far better off to put a blank check in the mail this afternoon. Or just have the new firms just send their bills directly to the KPMG CEO.

KPMG is not going to want to absorb that $15 million hit. Why are they going to have to write the check? Because of Mr. London’s alleged actions.

They will be looking to him to cover the cost.

Thus, we get back to the CEO’s comment.

KPMG will be bringing legal actions against London in the near future.

(By the way, keep in mind I’m an accountant, not an attorney, and I’m not giving any stock advice, and my comments here are based on what I know from reading a lot over the last few days, and I’m just a little ol’ sole practitioner. Wouldn’t be wise to read more into what I say than what I actually said.)

There is a very good chance the former partner will lose his equity in the firm and his retirement. There is a smaller chance he could write a really big check to his former employer.

Attitudes inside firm

An anonymous article at Going Concern from a KPMG insider gives some hint of the mood inside the firm. Check out KPMG Insider: Partners Fell Betrayed By Scott London’s Actions. If you’re still reading my overly long post, you will want to check out that article.

In my opinion, the feelings of betrayal amongst partners described by the author is a strong indication this is a radical departure from the firm culture. If what is alleged is true, Mr. London appears to be an extreme outlier.

One major thing described by the author is the internal communication. Look at this comment to see the very clear, unadorned reaction from the CEO. An email from him

…was one of the simplest and most powerful items I’ve seen come across the email in response to a firm event. Our chairman [John Veihmeyer] sent a simple email, just a few paragraphs, not even on the normal firm letterhead with his picture. Attached to the email was a copy of the complaint. In simple terms, the email said, “Everyone read this complaint. Read what this guy did. Know that we don’t stand for it and know that we won’t tolerate it.” No BS, no fluff and no leaving it up to us to read the complaint on Going Concern. I’ve had a chance to have some candid conversations with John Veihmeyer before and this email reflected those. Pundits can pick it apart but for me it was the kind of response I wanted from my firm.

He sent out a copy of the indictment and asked everyone to read it.  That e-mail is quite consistent with the restrained we will be pursuing legal action comment in the press release last week.

Not only has the firm thrown him under the bus, sounds like they are going to put the bus in reverse and drive over him again. Then back up further, get a running start, and run over him with the other tires.

I’m thinking a suit to recover $15M for damages would be more educational for all the partners, professional staff and support staff than a dozen hours of ethics training. The message? If anyone else ever does this again, or anything even vaguely similar, rest assured the firm will grind you into dust.

No classtime necessary – it would only take 2 emails. One attaching the text of the suit and the other with the court order to pay up.

So the answer to the question is yes, there are a lot of bad consequences to insider trading.

Previous posts here, here, and here.

Next post:  financial and emotional consequences.

Written by Jim Ulvog

April 17, 2013, 8:00 am at 8:00 am

Posted in Audits

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