After KPMG, Audit Firms Reconsider Procedures

Accounting firms are being forced to take a fresh look at their practices in the wake of an insider-trading scandal involving one of KPMG’s top auditors, as new rules requiring more transparency by the firms are already being considered.

The heightened scrutiny comes after news that a senior partner at KPMG revealed confidential information about two clients, Herbalife and Skechers, a move that led the firm to resign as the auditor of those companies.

The partner, Scott I. London, who was in charge of KPMG’s audit practice in Southern California, was fired by the accounting firm this week. Though he has not been charged, Mr. London admitted to wrongdoing in a statement issued through his lawyer on Tuesday. Mr. London said that he was “embarrassed” and that he regretted his “actions in leaking nonpublic data to a third party regarding the clients I served for KPMG.”

James D. Cox, a securities lawyer at Duke University, called the case a “bombshell that has the industry circling the wagons on training.” The profession, he said, “suffers from an acute case of schizophrenia. They drink the tea about being professionals, but the other side is that they identify all too closely with their clients.”

The case has been a jolt to the industry, particularly as insider trading is more commonly associated with investment firms than with auditing firms. All the so-called Big Four accounting firms are now re-examining their internal training, monitoring and compliance programs to identify loopholes that might allow an accountant to skirt securities regulations or internal policies, industry officials say.

The sector has already been under scrutiny, particularly after the accounting scandals of the last decade. A proposal by the Public Company Accounting Oversight Board, which regulates the profession, would require accounting firms to disclose an engagement partner’s name on a client’s audit reports and other papers. After the KPMG case, that could gain new support.

The accounting oversight board would take up the matter “within the next three to six months,” said a board spokeswoman, Colleen Brennan.

“I can envision that the KPMG case will be used to promote a listing of the names,” said Charles D. Niemeier, a former board member now in private practice at the law firm Williams & Connolly.

Only PricewaterhouseCoopers has strongly publicly backed the accounting board proposal, and only the part requiring identification of audit partners in annual forms, known Form 2, that accounting firms file to the regulator.

No accounting firm publicly backs the section requiring partners to sign audit reports that get filed to the Securities and Exchange Commission, as the industry fears auditors could be personally sued and that investors might develop a “star system” to rank auditors.

But the accounting industry wants to remain cohesive before the accounting board. Therefore, the KPMG case “is going to put additional pressure on the board to move forward with this,” said Joseph Carcello, an accounting professor at the University of Tennessee and a former KPMG employee, and an adviser to the accounting oversight board.

Still, at least one expert said the proposal to have partners personally sign audits could make the reviews riskier, not safer.

“You will chase away people who are unwilling to take the legal and reputational risk of making an honest mistake,” said Anthony Catanach, a professor at Villanova University’s business school . “You may unwittingly attract more risk takers instead, and get riskier audits.”

The latest news is also a setback for KPMG, which had settled various cases involving accounting scandals, including those at Rite Aid and Oxford Health Plans. In 2005, the firm narrowly averted indictment by agreeing to pay a $456 million penalty to the government for its role in the marketing of fraudulent tax shelters. Several tax partners in KPMG’s Los Angeles unit â€" the same as Mr. London’s â€" were indicted.

But in contrast to its mass-market tax shelter business, the latest episode appears to be a one-time case. KPMG “has a state of the art system, but this guy took it outside the system and did it in a way that had no trace,” said a senior person briefed on the matter who declined to be identified. “He had the right tone from the top, and he still did this. It could happen anywhere.”

Tim Connolly, a KPMG spokesman, did not return calls requesting comment.