A former KPMG LLP partner admitted passing on stock tips about clients to a friend in exchange for cash and gifts, in a scandal that led the big accounting firm to resign as auditor for two companies

Updated April 9, 2013, 8:42 p.m. ET

Trading Case Embroils KPMG

Herbalife, Skechers Scramble to Get New Auditors as Firm Resigns Their Accounts in Wake of Probe

By JEAN EAGLESHAM, JULIET CHUNG and HANNAH KARP

A former KPMG LLP partner admitted passing on stock tips about clients to a friend in exchange for cash and gifts, in a scandal that led the big accounting firm to resign as auditor for two companies.

Scott London, the Los Angeles-based partner in charge of the audits of the two clients until he was fired by KPMG, told The Wall Street Journal late Tuesday afternoon that “I regret my actions in leaking nonpublic data to a third party.”

Mr. London said his leaks “started a few years back,” adding that KPMG bore “no responsibility” for his actions.

“What I have done was wrong and against everything” he believed in, Mr. London said.KPMG had said late Monday that it was resigning as outside auditor to the two clients, identified Tuesday as nutrition company Herbalife Ltd. HLF -3.75% and shoe retailerSkechers USA Inc. SKX +1.86%

The Federal Bureau of Investigation and the Securities and Exchange Commission are investigating allegations of insider trading in the shares of certain KPMG clients, said people familiar with those probes.

The probes are the latest sign of authorities’ efforts to crack down on insider trading. They could amount to the latest black eye for a Big Four accounting firm, following widespread criticism by regulators and investors of audit firms’ failure to flag problems at large banks and securities firms in the years leading up to the financial crisis.

In resigning the two audit accounts, KPMG said it was withdrawing its blessing on Herbalife’s financial statements for the past three years and for Skechers for the past two. It stressed that it had no reason to believe there were any errors in the companies’ books. Both companies said they are moving to find new auditors.

Herbalife has been in the middle of a tug of war between hedge-fund manager William Ackman—who has questioned the company’s business model and taken a short position betting its stock will fall—and Herbalife investors Carl Icahn and Daniel Loeb. Herbalife shares fell 3.8% Tuesday, while Skechers shares rose 2%.

Neither KPMG nor Mr. London named the recipient of the tips. The person isn’t associated with a hedge fund or other professional investor, according to one person familiar with the matter.

Mr. London said that he didn’t pass any documents but spoke on the phone to the person. “He traded on the information, but…I am not aware of how much he profited,” Mr. London said.

Mr. London said the person he passed information to gave him a watch, bought him dinners from time to time and “on a couple of occasions” gave him $1,000 to $2,000 in cash.

KPMG doesn’t expect the events to lead it to resign from any additional audit engagements, according to a person familiar with the firm’s thinking. The Skechers and Herbalife accounts are the only ones in which Mr. London was the partner in charge of the audit, this person said.

Allegations that audit partners have exploited confidential client information haven’t happened often, according to legal experts.

“Audit partners obviously have access to potential insider information, by the nature of their job,” said Howard Schiffman, a partner at law firm Schulte Roth & Zabel LLP and a former SEC trial attorney. “However, we’ve not seen a large number of enforcement actions in this area, particularly involving the major accounting firms.”

One exception to this general rule: Thomas P. Flanagan, a former Deloitte & Touche LLP partner in Chicago, was sentenced last year to 21 months in prison after he pleaded guilty to securities fraud.

Authorities said Mr. Flanagan made $430,000 in illegal profits by trading on information about Deloitte clients such as Best Buy Co., BBY -0.85% WalgreenCo., WAG +1.36% Sears HoldingsCorp. SHLD +0.82% and Motorola Inc.

U.S. companies and audit firms typically don’t identify the individual partners who supervise each audit. Mr. London wasn’t named in Herbalife or Skechers filings as the KPMG partner in charge of their outside audits.

A 2011 proposal from the government’s audit-industry regulator would require that such partners to be identified. Some other countries already have such a requirement.

In this case, the alleged insider trading was detected by federal investigators, rather than the audit firm, according to people familiar with the matter. KPMG appears confident its systems weren’t to blame, said one of those people.

The firm fired Mr. London within 24 hours after it was alerted to allegations of impropriety, according to people familiar with the accounting firm.

KPMG clients CVB Financial Corp.,CVBF -0.18% a banking company, and insurer Unico American Corp.UNAM +0.37% said Tuesday they were monitoring the situation after learning their information wasn’t involved.

“Rogue employees do these types of things, but the question is, what controls does KPMG have to ensure that this kind of thing does not happen or will not happen in the future?” said Lester Aaron, chief financial officer for Unico American. “Rogue” is also a term KPMG used for the employee it fired.

Chris Myers, president of CVB Financial, the holding company for Citizens Business Bank, said KPMG has been “very succinct with their comments.”

Skechers said in a statement it was informed that its lead audit partner from KPMG was under federal investigation for allegedly providing nonpublic information about clients, including Skechers, to a third party “in exchange for money.”

David Weinberg, chief financial officer of Skechers, said he wasn’t told what information about Skechers was allegedly divulged, or to whom. KPMG has been Skechers’s auditor since before 1999, the year it went public, and Mr. London audited Skechers for two multiyear stretches, according to Mr. Weinberg, who recalls having dinner with Mr. London on several occasions.

“He was one of the last guys I would ever suspect of doing this,” said Mr. Weinberg.

The need for firms such as Skechers and Herbalife to have a new firm re-audit financial statements “is not trivial in terms of time and expense and disruption,” said Joseph Carcello, an accounting professor at the University of Tennessee.

Meet The KPMG Partner Who Allegedly Leaked Secret Client Data To The Highest Bidder

Tyler Durden on 04/09/2013 16:45 -0400

The KMPG partner at the heart of today’s Herbalife/KPMG fiasco was unknown for several hours, until finally his name resurfaced. Per Reuters:“Scott London, a partner at accounting firm KPMG, was the lead auditor for Skechers USA Inc who resigned after allegedly leaking insider information to traders, said Skechers Chief Financial Officer on Tuesday. In an interview, CFO David Weinberg said he was surprised to learn late on Monday from partners at KPMG that London had admitted to the allegations and was leaving the firm.”

And from the WSJ:

KPMG said late Monday that the partner had allegedly provided inside information about its clients to someone who had used that information in stock trading. That person wasn’t connected with the battle between Messrs. Ackman and Icahn over Herbalife, said a person familiar with the situation. The recipient of the alleged insider information hasn’t been named.

KPMG didn’t name the partner involved in the allegations, whom it described as in charge of its audit practice in its Los Angeles business unit.

KPMG partner Scott London headed the audit of Herbalife for the accounting firm. Mr. London didn’t immediately respond to requests for comment.

Introducing Scott (Via LinkedIn). We are confident the SEC, FBI and the DOJ (long after the fact) will be delighted to make an acquaintance.

Bloomberg’s Jon Weil did some more sleuthing and found out that Scott London…

… also has an interesting side gig: Chairman of the Los Angeles Sports Council. The nonprofit describes its mission as “the promotion of spectator sports programs in the Los Angeles and Orange County area, including support of our local teams and the attraction of events to the area.”

Here’s where that connection gets curious. Look on the left-hand column of the sports council’s website, under the heading “Supporting Our Local Teams,” and you’ll see a list of logos and names, including Major League Soccer’s Los Angeles Galaxy. And what’s the first thing you notice when you click on the Galaxy? Herbalife and its logo are all over the team’s website, including across the front of the Galaxy players’ jerseys. That’s because Herbalife, which sells nutritional supplements, is the team’s main sponsor.

Yet perhaps there was another reason for investors to wonder about KPMG’s independence from Herbalife, or at least the appearance thereof: London is chairman of an organization that, quite literally, is a cheerleader for a professional sports franchise that is inseparable from Herbalife and its brand.

Maybe there was a connection between London and Herbalife after all…

One wonders if following the demise of expert networks in late 2010 as a legitimate source of paid inside information, the hedge fund community realized there is a just as eager, and potentially cheaper source, of insider info on companies they want to buy or sell. And that source just happens to be partners (disgruntled or otherwise), and other staffers at Big 4 accounting firms.

One also wonders just how deep the rabbit hole revealed by Scott will be, and just how many hedge funds are exposed to have generated “alpha” thanks solely to the information provided by Scott and others like him.

We can’t wait to find out.