SEC.gov | SEC Charges Hedge Fund Trader With Insider Trading in Carter’s Stock
The Securities and Exchange Commission today announced insider trading charges against a New York-based investment professional who used nonpublic information about youth clothing company Carter’s Inc. to give the hedge fund where he worked a $3.2 million trading edge.
The SEC alleges that Mark Megalli obtained the inside information through a consulting agreement he had with the former vice president of investor relations at Carter’s, Eric Martin, who the SEC has previously charged among several others in its investigation into insider trading of Carter’s stock. Martin, who had left Carter’s and started his own consulting firm, maintained contact with at least one company insider and obtained confidential information in advance of market-moving events that he supplied to Megalli so he could trade on it. Megalli enabled hedge fund Level Global Investors L.P. to avoid approximately $2.4 million in losses and make $853,655 in illicit profits by trading shares ahead of positive or negative news.
“The information was hot enough that Megalli sometimes conducted the trades while he was still on the phone with his source,” said William Hicks, associate regional director of the SEC’s Atlanta Regional Office. “After one profitable trade, Megalli bragged to his colleagues about being ‘max short’ in advance of negative news without mentioning his inside source.”
As always, I’m surprised at how little coverage these kinds of crime get. Often, I will find no stories at all on SEC charges. In this case, four news outlets covered the story, Reuters, hedgco.net, FINalternatives and OPALesque. I will be watching to see if there is coverage by more of the media but I do not have high expectations.
Insider trading is the trading of a public company‘s stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the company. In various countries insider trading based on inside information is illegal. This is because it is seen as being unfair to other investors who do not have access to the information.
I think that the scope of insider trading will be extended to other activities like HFT, Politiciens, Lobbyist, Dark Pools operators and owners and also the TBTF banskters institutions which have been, are… able to socialize losses versus reaping fat profits and bonuses.
(I honored to have the Ethics Sage, Steven Mintz, write a post for my blog. Please visit his blog at Ethics Sage.)
KPMG Insider Trading Scandal Damages the Reputation of the Accounting Profession
What possesses an audit partner to trade on inside information and violate the accounting profession’s most sacred ethical standard of audit independence from one’s client? Is it carelessness, greed, or ethical blindness? In the case of Scott London, the former partner in charge of the KPMG’s Southern California’s regional audit practice, it was some of each that motivated him to violate ethical standards and, in the course of doing so, causing the audit opinions signed by London on Skechers and Herbalife to be withdrawn by the accounting firm.
This case has a local twist as pointed out by Stephen Nellis in his column “Deckers, PCBC were victims of auditor leaks” in the April 19-25 Pacific Coast Business Times. Nellis notes that two companies affected are Goleta-based Deckers and Pacific Capital Bancorp, the former parent of Santa Barbara Bank & Trust now part of Union Bank.
Overall, Shaw is charged with leaking confidential information to his friend, Brian Shaw, about Deckers, Pacific Capital Bancorp, Manhattan Beach-based Skechers, and Los Angeles-based Herbalife. The leak of information about quarterly earnings information led to Shaw’s unjust enrichment of $1.27 million. Shaw, a jewelry store owner and country club friend of London repaid London with $50,000 in cash and a Rolex watch, according to legal filings.
The leaking of financial information about a company to anyone prior to its public release affects the level playing field that should exist with respect to personal and business contacts of the leaker and the general public. It violates the fairness doctrine in treating equals, equally, and it violates basic integrity standards. The KPMG scandal concerns me because a pattern of such improprieties may be developing.
In 2010, Deloitte and Touche was investigated by the SEC for repeated insider trading by Thomas P. Flanagan, a former management advisory partner and a Vice Chairman at Deloitte. Flanagan traded in the securities of multiple Deloitte clients on the basis of inside information that he learned through his duties at the firm. The inside information concerned market moving events such as earnings results, revisions to earnings guidance, sales figures and cost cutting, and an acquisition. Flanagan’s illegal trading resulted in profits of more than $430,000. In the SEC action, Flanagan was sentenced to 21 months in prison after he pleaded guilty to securities fraud. Flanagan also tipped his son, Patrick, to certain of this material non-public information. Patrick then traded based on that information. His illegal trading resulted in profits of more than $57,000.
The KPMG case is a particularly egregious one because it involves insider trading by an auditor of client stock. This incident jogged my memory and I came up with a characterization of London’s actions as “stupid is as stupid does.” Scott London, the partner in charge of audits of Herbalife Ltd. and Skechers USA Inc., traded on inside information for personal gain. KPMG resigned as the auditor of both companies after learning that London provided non-public information about the companies to a third party, who then used the information in stock trades. The firm fired London.
In resigning the two audit accounts, KPMG said it was withdrawing its blessing on the financial statements of Herbalife for the past three years and of Skechers for the past two. KPMG stressed, however, 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.
In a statement that should raise red flags for all CPA firms that audit public companies, KPMG stated it had concluded it was not independent because of alleged insider trading. Independence is the foundation of the accounting profession and the cornerstone of an audit conducted in accordance with generally accepted auditing standards. The public (i.e., shareholders and creditors) relies on auditors’ independence, objectivity, and integrity to ensure that the audit has been conducted in accordance with such standards and that the financial statements are free of material misstatements.
I’m having a hard time understanding the stupidity and moral blindness of London in this case. Surely he knew of his ethical obligations. All audit firms supposedly have been carefully assessing independence in the aftermath of financial frauds in the late 1990s and early 2000s (i.e., Enron and WorldCom). Firms generally have quality controls in place to prevent compromises to audit independence.
Trading on insider information for cash and gifts is bad enough, and when done by an audit partner it is unforgiveable. Even more baffling to me is that the quid pro quo for passing along stock tips about clients to a friend for London was to receive cash and gifts in return. According to London, he received a discount on a watch, and the friend bought him dinners from time to time and on a couple of occasions gave him $1,000 to $2,000 in cash. A cynic might say he sold himself cheap.
So, what happens next? Both Herbalife and Skechers will need to have their financial statements re-audited, not an inexpensive proposition. Even though the companies were not at fault, the public may misunderstand and think the companies were complicit in the matter.
For KPMG, the insider trading investigation is a setback. The accounting firm has worked hard to rehabilitate its reputation after coming under scrutiny last decade in a wave of corporate accounting scandals and the firm’s role in the marketing of fraudulent tax shelters. KPMG paid large nine-figure settlements to resolve lawsuits related to accounting scandals at the drugstore chain Rite-Aid and Oxford Health Plans. In 2005, the firm paid a $456 million penalty to the government related to tax fraud.
I have to wonder whether insider trading by partners at Deloitte and KPMG portends a larger scandal on the horizon. It seems every ten years or so the accounting profession finds itself in a “pickle” and hauled before Congress to explain its actions. It is about that time following financial frauds at Enron, WorldCom and a host of other companies. I don’t know how to get the message across to those in the profession that every time such incidents occur, and now insider trading, the public loses patience with the profession and doubts begin to surface about whether the profession truly acts to protect the public interest.
Blog Posted by Steven Mintz, aka Ethics Sage, on April 12, 2013