KPMG Pays $50 Million to Settle PCAOB Case with SEC

Market professionals are key gatekeepers to the markets and the investing public. The proper implementation of their professional duties is a critical component of the new ethics the federal securities laws were designed to instill in the markets for the protection of all. When those professionals fail it not only undermines the protections that Congress crafted, it eats away at the core trust and confidence on which the markets are predicated and that is critical to investors.

The impact of a case such as In the Matter of KPMG, LLP, Adm. Proc. File No. 3-19203 (June 17, 2019) cannot be overstated. The facts to this sad tale of eschewing professional ethics in favor of cheating is well known, having been detailed in criminal and civil charges and testified to in widely followed court proceedings. The facts were also admitted by the audit giant as part of resolving the SEC’s administrative charges.

The tale begins with the audit firm receiving unsatisfactory reviews from PCAOB inspectors for its audit work. The inspections are part of the core protections designed to ensure that audit firms such as KPMG are fulfilling their gatekeeping function. The firm sought to do better. It hired Brian Sweet, an Associate Director at the PCAOB who had worked on the inspection team assigned to the auditor. Before leaving his post at the Board, Mr. Sweet copied a trove of confidential PCAOB materials onto a computer drive which was later dumped into the system at his new employer.

From the moment he arrived at KPMG, Mr. Sweet was pumped for information about the inspection process by a variety of firm partners which traced to the highest echelons of KPMG. He was reminded about the source of his paycheck and told to be loyal to his new employer.

Mr. Sweet was forthcoming, furnishing information which included, for example, “a number of KPMG banking clients the PCAOB planned to inspect in 2015,” according to the Order, despite the confidential nature of such information. Other confidential information drawn from the trove included the Board’s selection criteria for audits and PCAOB comment forms tied to the Board’s inspection of a Spanish bank, used to aid a firm partner pitching another bank for work. Mr. Sweet also called a Board employee to secure confidential information about the inspection process that went beyond his purloined trove.

Despite the flow of inside information, KPMG’s audit work continued to be criticized. In early 2016 audit firm representatives met with the Chief Accountant’s Office at the SEC. The staff “expressed significant concerns about the firm’s audit quality and questioned whether KPMG was adequately addressing these issues.” At about the same time Board Inspections Leader Jeffrey Wada furnished a list of 13 KPMG clients that would be inspected as part of a tantrum following his failure to receive a promotion to his long time friend Cynthia Holder who had joined the audit firm months before. The information was used to conduct a review of recent firm audits where the workpapers had not been “locked.”

The next year Mr. Wada furnished his friend with more information. In January 2017 he sent Ms. Holder a list of preliminary Board inspection targets. The next month he updated the information, giving her 47 “ticker symbols” which Ms. Holder understood was the final list of KPMG audits that would be inspected. While those with whom the information was shared were cautioned to be circumspect as it was disseminated to aid the ailing audit giant, eventually it was reported and KPMG began to investigate.

Obtaining and deploying confidential Board information to try and bolster its performance scores was not the only malady from which KPMG was suffering during this period. The firm’s efforts to ensure that its professionals met their continuing education requirements and improve the readiness of its professionals was undercut by a number of its empoyees who essentially “cheated on their exams,” student style. KPMG audit professionals, for example, shared exam answers. Others made unauthorized changes to server instructions that permitted them to manually select the scores necessary to pass the tests. Eventually, these practices came to light and the firm retained an outside law firm that launched an internal investigation.

The Order alleges violations of PCAOB Rule 3500T which requires audit firms to “maintain integrity when performing any professional service in connection with the preparation or issuance of any audit report.” In resolving the matter, the Commission considered the fact that the audit firm reported the matters, initiated an investigation of the professional testing matter and its cooperation.

KPMG also agreed to implement a series of undertakings which included a review of its quality controls relevant to ethics and integrity, filing a report with the Commission, the delivery of a report from a Special Committee conducting an investigation and the retention of an independent consultant.

In resolving this matter KPMG consented to the entry of a cease and desist order based on the PCAOB Rule cited above and to a censure. The firm also agreed to pay a penalty of $50 million.

FCPA Institute: On June 20 and 21, 2019, Professor Mike Koehler will conduct the FCPA Institute at the Offices of Dorsey & Whitney LLP in Minneapolis, Minnesota. The Institute provides a unique learning experience for those seeking to elevate their knowledge of the Foreign Corrupt Practices Act. Professor Koehler is one of the foremost scholars on the FCPA and conducts an interesting and most informative program. The program is live in Minneapolis and also webcast. You can obtain more information about the program and register here.

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This Week In Securities Litigation (Week ending June 14, 2019)

The Commission did not file any new enforcement actions this week. The agency did, however, settle or partially resolve, three pending enforcement actions.

Congress again took up the question of inspecting the auditors and work papers for U.S. traded issuers. Legislation was introduced to require such action. This, of course, is nothing new. In 2002 the Sarbanes Oxley Act imposed such a requirement which the PCAOB was directed to implement. For the most part that requirement has been met. The exception – China.

Finally, Singapore and U.K. authorities entered into a consultation of cyber securities, a key issue for all firms.

Congress

PCAOB Inspections: Senators Rubio and Menendez introduced legislation which would require that the PCAOB inspection of Chinese issuers, among others. The bill, in essence, seeks to effectuate the promise of the Sarbanes Oxley Act by requiring auditors of China based issuers, as well as all others, permit inspections. From the beginning the Chinese government has largely refused. Despite enforcement actions, and repeated discussions between U.S. and Chinese officials, little has changed over the years. The legislation seeks to remedy this situation. While the Board could revoke the registration of audit firms which do not furnish the work papers and permit inspection, to date it has not invoked this authority with respect to Chinese issuers who typically cite local law and CSRC when not producing the requested work papers.

SEC Enforcement – Filed and Settled Actions

The Commission filed no civil injunctive actions and no administrative proceedings this week, exclusive of 12j and tag-along actions.

Insider trading: SEC v. Salis, Civil Action No. 2:16-cv-00231 (N.D. Ind.) is an action which named as defendants Christopher Salis, a former SAP executive, and two of his friends, Douglas Miller and Edward Miller. The action centered on the acquisition by SAP of Concur Technologies. Prior to the deal announcement Mr. Salis, who had been entrusted with confidential information about the transaction by a close friend at Concur, tipped Douglas Miller who then tipped Edward Miller. Each man traded prior to the deal announcement along with other friends and family members. Collectively the group secured trading profits of over half a million dollars. This week the Court entered final judgments resolving all the issues as to each Defendant. The final judgment as to each Defendant, entered by consent, prohibits future violations of Exchange Act Sections 10(b) and 14(e). In addition, Mr. Salis will pay disgorgement of $90,000 along with prejudgment interest of $2,067; Douglas Miller will pay disgorgement of $119,003 along with prejudgment interest of $22,258; and Edward Miller will pay disgorgement of $149,117 along with prejudgment interest of $27,891. The monetary component of each judgment will be deemed satisfied by the forfeiture orders entered in the parallel criminal action brought by the Fraud Section of DOJ. In that case Mr. Salis pleaded guilty to conspiracy to commit securities and wire fraud and was sentenced to serve six months in prison. Douglas Miller pleaded guilty to conspiracy to commit securities and wire fraud and making false statements and was sentenced to serve twenty-four months in prison. Edward Miller pleaded guilty to one count of conspiracy to commit securities and wire fraud and to obstruction of justice and was sentenced to serve six months in prison. See Lit. Rel. No. 24499 (June 12, 2019).

Insider trading: SEC v. Fishoff, Civil Action No. 24498 (S.D.N.Y.) is a previously filed action against, among others, Winston Tang and Deshan Govender, two friends. Mr. Tang was the vice president clinical research for Sangamo BioSciences, Inc. This week the Court entered final judgments by consent against the two men, imposing permanent injunctions based on Exchange Act Section 10(b). The judgment as to Mr. Tang also imposed a penalty of $750,000. The judgment as to Mr. Govender provides that the Court will consider monetary penalties in the future. The underlying complaint alleges that prior to the announcement of a licensing agreement between Sangamo and another firm Mr. Tang tipped his friend who traded. Mr. Govender later tipped Steven Fishoff who was part of an insider trading ring. Ultimately the trading resulted in about $1.5 million in profits. See Lit. Rel. No. 24498 (June 11, 2019).

Misappropriation: SEC v. Kitts, Civil Action No. 1:18-cv-11507 (D. Mass.) is a previously filed action against investment adviser Kimberly Pine Kitts. The SEC’s complaint alleged that over a six year period Ms. Kitts misappropriated over $3 million from client investment and retirement accounts. The Court entered a final judgment imposing permanent injunctions based on Advisers Act Sections 206(1), 206(2) and Exchange Act Section 10(b). The judgment also requires her to pay $2,882,221 in disgorgement and prejudgment interest. Her payment obligation is deemed satisfied by the entry of a restitution order entered in the parallel criminal case. Defendant was, in addition, barred by the Commission from the securities business and from participating in any penny stock offering. See Lit. Rel. No. 24497 (June 11, 2019).

Criminal Cases

Offering fraud: U.S. v. Falcone, No. 19-cr-257 (E.D.N.Y.). Defendant Joseph Falcone is the owner of 3G’S VINO LLC. He developed a product that is a sealed glass holding a single serving of wine. The product was sold at his stores. His creation was also featured on the national television show “Shark Tank.” Potential investors were solicited for about a year beginning in September 2014. They were told about the single glass of wine product featured on TV. Investors were also told their money would be put into developing the business. The investor funds came in. Those same funds also went out, but not to 3G’S VINO as promised. Rather, over half a million dollars in investor money went to acquire a home in Florida and fund online securities trading by the wine store owner. Mr. Falcone pleaded guilty to one count of wire fraud on June 10, 2019. The date for sentencing has not been announced. U.S. v. Falcone, No. 19-cr-257 (E.D.N.Y.).

Insider trading: U.S. v. Jung, No. 1:18-cr-00518 (S.D.N.Y.) is an action which named as a defendant Woojae Jung, an employee at an investment bank. This week Mr. Jung was sentenced to serve three months in prison for insider trading. The underlying charges alleged that on multiple occasions he accessed material non-public information at his firm and used it trade in advance of corporate transactions. As a result, he netted nearly $130,000 in illicit profits. The sentence also directed that Mr. Jung pay a penalty of $30,000, forfeit the trading profits and be subject to two years of supervised release following his release from prison. See also SEC v. Jung, Civil Action No. 1:18-cv-04811 (S.D.N.Y.).

Anti-Corruption/FCPA

World Bank: The bank debarred Dongfang Electronics Co. Ltd, a Chinese electrical engineering firm. The action came in connection with bids for the Liberian Accelerated Electricity Expansion Project $60 million contract. Additional financing was being sought to increase access to electricity and strengthen institutional capacity in the West African country’s energy sector.

Dongfang was charged with engaging in fraudulent practices. Specifically, the firm was alleged to have falsified two letters during the bidding process. This is considered a fraudulent practice. The debarment has a term of 15 months. It also qualifies for cross-debarment by the Asian Development Bank, the European Bank of Reconstruction and Development, the Inter-American Development Bank and the African Development Bank. In connection with the resolution Dongfang has undertaken to strengthen its procedures.

Singapore

The Monetary Authority of Singapore and the Bank of England announced a collaboration on cyber security. The collaboration will involve MAS and the UK financial authorities identifying effective ways to share information on the topic. The two authorities already cooperate on cyber security bilaterally and by supporting the Basel Committee’s work to develop best practices to supervise cyber risk in banks and contributing to the Financial Stability Board’s Cyber Lexicon.

FCPA Institute: On June 20 and 21, 2019, Professor Mike Koehler will conduct the FCPA Institute at the Offices of Dorsey & Whitney LLP in Minneapolis, Minnesota. The Institute provides a unique learning experience for those seeking to elevate their knowledge of the Foreign Corrupt Practices Act. Professor Koehler is one of the foremost scholars on the FCPA and conducts an interesting and most informative program. The program is live in Minneapolis and also webcast. You can obtain more information about the program and register here.

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