the auditor of nutritional-supplement maker Herbalife Ltd. and shoe company Skechers USA Inc. and said it had fired a senior partner in its Los Angeles office over alleged insider-trading tips. The Securities and Exchange Commission is investigating the trading, according to people familiar with those probes. Herbalife shares have been closely watched amid a public battle by two hedge-fund managers, William Ackman and Carl Icahn, over the company’s value and practices. 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, which 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. Herbalife said KPMG told the company it was resigning as its independent accountant solely because of the impairment of its independence resulting from the former partner’s alleged unlawful activities and not for any reason related to Herbalife’s financial statements.
KPMG is resigning as auditor of two companies because of concerns that a senior partner has allegedly provided insider-trading tips. In addition, KPMG is withdrawing its audit reports on Herbalife’s financial statements for 2010, 2011, and 2012, as well as the report on the effectiveness of internal control over financial reporting for those periods. KPMG is also withdrawing its auditing reports for Sketchers for fiscal years 2011 and 2012. KPMG described the partner that may have provided insider information as “rogue” and someone who violated the firm’s rigorous policies and protections. At this point, KPMG has no reason to believe the financial statements contained any errors.
Respond the following questions:
a. Do you think the integrity of KPMG auditing services has been damaged by the allegation that one of its senior partners would provide insider trading information?
b. Although Herbalife has become controversial because of questions raised about its business model, this allegation apparently does not relate to that controversy. Why do you think this new allegation has still caused Herbalife shares to fall after the announcement was made?
c. How could a high-integrity accounting firm such as KPMG protect itself against a rogue partner tarnishing the reputation of the firm in the future?
d. How does an auditor’s independence provide the basis for issuing an opinion on a company’s financial statements?
e. How did Mr. London’s actions violate his auditor’s independence? What action was KPMG then obliged to take when it learned of Mr. London’s actions?
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