Securities Industry Commentator by Bill Singer Esq

June 18, 2019
KPMG LLP agreed to settle SEC charges that the firm had altered past audit work after receiving stolen information about inspections of the firm that would be conducted by the Public Company Accounting Oversight Board ("PCAOB"); also the SEC Order found that numerous KPMG audit professionals cheated on internal training exams by improperly sharing answers and manipulating test results. KPMG acknowledged that its conduct violated a PCAOB rule requiring the firm to maintain integrity in the performance of a professional service and provides a basis for the SEC to impose remedies against the firm pursuant to Sections 4C(a)(2) and (a)(3) of the Exchange Act and Rules 102(e)(1)(ii) and (iii) of the Commission's Rules of Practice. Previously, five former KPMG officials were charged for their roles in interferomh with the PCAOB's ability to detect audit deficiencies at KPMG. Further, KPMG audit professionals who had passed training exams (mandatory continuing professional education, ethics and integrity, and training mandated by a prior SEC order finding audit failures) sent their answers to colleagues to help them also attain passing scores; and others manipulated an internal server hosting training exams to lower the score required for passing.  In settling the charges, KPMG agreed pay a $50 million penalty and the firm wil; comply with a detailed set of undertakings, including retaining an independent consultant to review and assess the firm's ethics and integrity controls and its compliance with various undertakings. As set forth under the "Summary" title in the SEC Order [Ed: footnotes omitted]:

1. This matter involves two separate courses of misconduct that resulted in violations of the fundamental requirement that auditors act with integrity. 

2. First, from 2015 to 2017, now-former senior members of KPMG's Audit Quality and Professional Practice group ("AQPP" or "National Office") - which is responsible for the firm's system of quality control - improperly obtained and used confidential information belonging to the Public Company Accounting Oversight Board ("PCAOB" or "Board") in an effort to improve the results of the PCAOB's annual inspections of KPMG audits. The information obtained included lists of the specific audit engagements the PCAOB planned to inspect, the criteria the PCAOB used to select engagements for inspection, and the focus areas of the inspections. The personnel sought the information because the firm had experienced a high rate of audit deficiency findings in prior PCAOB inspections and had made improving its inspection results a priority 

3. After obtaining the confidential list of the PCAOB's planned inspections in 2016, the now-former KPMG personnel oversaw a program to review and revise certain audit workpapers after the audit reports had been issued to reduce the likelihood that the PCAOB would find deficiencies in those audits. This effort resulted in a substantial improvement to KPMG's 2016 inspection results. In 2017, the now-former KPMG personnel again obtained the list of audit engagements that the PCAOB planned to inspect, but the misconduct was discovered by others within the firm and reported to KPMG leadership before relevant workpapers could be changed. In addition, a now-former KPMG partner attempted to use improperly-obtained confidential information relating to the PCAOB's inspection of another audit firm to win new business for KPMG. 

4. Second, before, during, and after the senior National Office professionals used confidential PCAOB information, KPMG audit professionals - at all levels of seniority - engaged in misconduct in connection with examinations on internally-administered training courses that were intended to test whether they understood a variety of accounting principles and other topics of importance. 

5. This misconduct took a variety of forms. KPMG audit professionals shared exam answers with one another. A number of audit partners gave exam answers to other partners, and a number also sent answers to and solicited answers from their subordinates. In addition, for a period of time up to November 2015, certain audit professionals made unauthorized changes to KPMG's server instructions that allowed them to manually select the scores necessary to pass the tests, which they often lowered to the point of passing exams with less than 25 percent of the questions answered correctly. The exams related to a variety of subjects that were relevant to the test-takers' audit practices, and included additional training required by a 2017 Commission Order after the Commission found that KPMG engaged in improper professional conduct and had caused a client's reporting violations.

6. After discovering the training-related misconduct, KPMG reported the matter to Commission staff and appointed a Special Committee of its Board of Directors to oversee an internal investigation. During that investigation, two now-former partners who had shared exam answers deleted relevant documents. One of those partners and certain other audit professionals made misrepresentations to the firm's investigators. 

7. KPMG is required, both by PCAOB rules and by the Code of Conduct of the American Institute of Certified Public Accountants ("AICPA"), to act with integrity in connection with the professional services it provides its clients. Certified public accountants are required to "be, among other things, honest and candid within the constraints of client confidentiality." By the misconduct described herein, these professionals caused KPMG's failure to act with the integrity required of a public company auditor. 

8. As indicated above, KPMG's Board of Directors has formed a Special Committee led by an independent board member to oversee an investigation of the misconduct relating to training examinations. The Special Committee has retained an outside law firm to investigate the extent of such conduct within the past three years, and will recommend employment actions to KPMG management as appropriate. As set forth in the Undertakings below, KPMG will retain an independent consultant to review and assess the Special Committee's investigation and whether the firm has taken appropriate employment actions or other remedial steps, and to ensure the firm has designed and implemented quality controls that reasonably assure compliance with all professional standards relating to ethics and integrity.
At first blush it looks like a fairly common customer complaint. You got an irate public customer naming six respondents in an effort to recover six figures in alleged damages. Just going by the FINRA Arbitration Decision, you're not all that worked up about the she-says-they-say aspect of the dispute, and, hey, who the hell really knows, right? Then you start digging, and, wow, it doesn't look like the customer was blowin' smoke! After a while, you begin to wonder if Wall Street is simply a cesspool. When they get a bad actor in this biz, does anyone give a crap? What's the point of all those regulators on Wall Street? In the end, you don't come away with a good feeling about your investments and the reputation of an industry.

Stockbroker Suspended For Prearranged Trading Scheme With Prop TraderIn the Matter of Brian Colin Doherty, LLC., Respondent (FINRA OHO Decision  2015047560501)
In August 2018, FINRA's Department of Enforcement filed a three-cause Complaint against Brian Colin Doherty 
  • alleging that he had willfully violated Section 10(b) of the Securities Exchange Act (requiring proof of "scienter"), Exchange Act Rule 10b-5, and FINRA Rules 2020 and 2010 by engaging in a fraudulent, prearranged trading scheme in May and June 2015;
  • As an alternative to cause one, cause two alleges that he had  violated FINRA Rule 2010 by negligently engaging in a prearranged trading scheme in violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act; and 
  • As an alternative to causes one and two, cause three alleges that Doherty violated FINRA Rule 2010 by aiding and abetting TS's fraudulent, prearranged trading scheme.
Representing himself pro se, Doherty admitted in his Answer to executing trades on behalf of TS but claimed that:

because he was unsure of the legality of the trades, he first discussed them with his desk manager and individuals in BGC's compliance department. According to Doherty, they told him the trades were acceptable as long as there was market risk, and they suggested there would be market risk if BGC held the bonds for four hours. . . . 

After a three-day Office of Hearing Officers Hearing, the FINRA Hearing Panel found as noted in the "Syllabus":

Respondent, a registered representative at an interdealer broker, intentionally engaged in a fraudulent, prearranged trading scheme to enable his customer, the trader of a proprietary account at another member firm, to evade that firm's aged inventory policy. For this misconduct, Respondent is suspended from associating with any member firm in any capacity for two years and ordered to pay restitution of $56,093 plus interest.

In determining the imposition of sanctions, the Hearing Panel noted in part the following aggravating factors [Ed: Footnotes omitted]:

First, Doherty attempted to conceal his misconduct from his firm and to shift responsibility for his actions to BGC's compliance department. Although Doherty admitted that he executed the transactions at issue at preset prices, he has not accepted responsibility for willingly executing prearranged trades designed solely to evade Scotia's Aged Inventory Policy. Throughout this proceeding, Doherty deflected responsibility by suggesting that BGC's compliance department had approved of the prearranged trading scheme. Doherty argued that he never tried to hide his misconduct. We disagree. Doherty disclosed only select portions of his plan to Eckert and Sulfaro, used a code word to disguise his trading, split return-leg tickets, and sold short to conceal his misconduct.We find Doherty's efforts to shift responsibility for his actions and conceal his misconduct from the firm aggravating.

We also find it aggravating that Doherty acted intentionally or, at a minimum, recklessly. The sole purpose of Doherty's prearranged trading scheme was to avoid Scotia's Aged Inventory Policy, and he knew that Scotia would incur commission costs for these sham transactions. He agreed to conceal the trades by using a secret code word, sometimes splitting the ticket on the return trip, and reversing the order of purchases and sales. At every step, Doherty exhibited intent and knowledge. We find the intentional nature of his misconduct aggravating. 

We also find it aggravating that Doherty engaged in a pattern of misconduct that spanned two months and involved 19 series of prearranged transactions (approximately 50 individual trades).  Furthermore, Doherty stopped the prearranged trading scheme only when Scotia fired TS for prearranged trading. Also aggravating is the harm that Doherty's misconduct caused Scotia. Because Doherty executed transactions that had no real business purpose for Scotia, the firm incurred commission costs of $56,093 for no reason. 

Conversely, Doherty benefitted from his misconduct. This too is aggravating.Doherty testified that he generally earned approximately one-third of the commissions he generated for BGC (adjusting for the costs and expenses deducted from his 55 percent payout). Crediting Doherty with his one-third estimate, he stood to earn approximately $18,700 in two short months, solely from the commissions Scotia paid BGC. Additionally, he engendered goodwill with a difficult customer who, as Doherty's second-largest account, Doherty had an interest in maintaining. Overall, we find that Doherty benefitted from his misconduct and that this fact is aggravating.

Pages 24 - 25 of the FINRA Decision

Bill Singer's Comment: Yet another in what seems to be an ever-expanding trend of well-written OHO Decisions.  Regardless of whether you agree or disagree with FINRA's regulatory agenda, or with the merits of a given case, there is no question that the Decisions coming out of both OHO and NAC have shown marked improvement in terms of content and context in the last few years -- and Doherty is another such example. Frankly, even a cranky pain-in-the-ass such as me has a hard time criticizing this prosecution, the Panel's conclusions, and the sanctions. Job well done all around!
Cynthia Williams-Singleton pled guilty in the United States District Court for the Western District of North wire fraud arising from her misuse of her access to her victims' retirement accounts. As set forth in part in the DOJ Release:

[F]rom December 2016 to June 2018, Williams-Singleton was a customer service representative with a call center located in Charlotte, for a company identified in court documents as "Company 1." As a call center representative, Williams-Singleton worked on accounts associated with "Client A," and had access to Company 1's data systems that contained, among other things, retirement fund records for Client A's benefit plan participants and their beneficiaries. 

As Williams-Singleton admitted in court today, during the relevant time period, she engaged in a scheme to defraud Client A's benefit plan participants and their beneficiaries by fraudulently transferring funds from their accounts to bank accounts under her control.  During the course of the scheme, Williams-Singleton fraudulently withdrew approximately $458,772.88 in participant and beneficiary funds from approximately eight participant accounts without authorization. Generally, the holders of the participant accounts victimized by Williams-Singleton were persons over the age of 70.

According to court documents, to carry out the scheme, Williams-Singleton used her misused her access to the victims' personally identifiable information and retirement fund records to make unauthorized changes to beneficiary data and to make unauthorized transfers of funds from Client A's plan participants' retirement accounts into bank accounts in her own name or under her control. Williams-Singleton typically accessed a participant's account when the participant contacted the call center. After speaking with the participant and discovering that the participant was unsure or unaware of his or her account balance, Williams-Singleton informed the participant that the participant's account was either empty, or had less than it did. She then added herself, her relatives and others, as beneficiaries of that participant's account.  Court records show that Williams-Singleton sometimes added her residential address and personal cell phone numbers as contact information on the account.

During today's plea hearing, Williams-Singleton admitted that she diverted funds from the participants' accounts to herself and other newly-added beneficiaries, and that, at times, Williams-Singleton called the call center and impersonated relatives of participants. Williams-Singleton further admitted to falsely reporting the death of the some participants in order to initiate the process of disbursement of funds to the beneficiaries that been fraudulently added.

South Carolina Man Is Sentenced To More Than Three Years For $1 Million Investment Scheme And Tax Evasion (DOJ Release)
Nickolas M. Godfrey was sentenced in the United States District Court for the Western District of North Carolina to 37 months in prison plus two years of court supervision, and he was ordered to pay over $1.6 million in restitution. As set forth in part in the DOJ Release:

[F]rom 2012 to at least 2015, Godfrey obtained more than $1 million by engaging in a Ponzi scheme through his company, Coast to Coast Business Funding LLC (Coast to Coast), which purportedly provided short-term cash advances to businesses.  Over the course of the scheme, Godfrey induced at least 20 victims to invest with Coast to Coast, by falsely representing that the company was successfully generating substantial revenue.  Godfrey maintained a website for Coast to Coast, which also falsely represented that the company was accredited by the Better Business Bureau. To further solicit investments from victims, Godfrey made numerous false representations to victims, including promising returns of as much as 73.5%.

Contrary to promises made to victim investors, Godfrey used victims' money to pay for personal expenditures and for the expenses of his other businesses, and to make Ponzi-type payments to earlier victims. 

When victims complained about missed payments and demanded more information, Godfrey tried to appease them by creating fake documents, including fake financial statements for Coast to Coast, and a fake list of clients to which Coast to Coast had purportedly provided financing.

In addition to the investment fraud scheme, Godfrey engaged in in a tax evasion scheme by evading the payment of tax liabilities assessed by the IRS related to his ownership and operation of two hair salons, Bliss Day Spa & Salon (Bliss) in Pineville, N.C., and Alter Ego Salon & Day Spa (Alter Ego) in Charlotte.  Godfrey committed tax evasion by, among other things, failing to pay federal employment taxes that he had withheld from the paychecks of employees at Bliss and Alter Ego, and taking multiple steps to thwart the IRS' collection efforts. For example, Godfrey commingled the amounts withheld from his employees' paychecks with other business and personal funds, including money obtained from victim investors, and used those funds to pay for personal expenses. Godfrey also lied to IRS employees attempting to collect the unpaid taxes. In addition, Godfrey filed individual U.S. Federal Income Tax Returns for the years 2009 through 2012 that failed to report accurately the net income he received from his businesses.