A former high-ranking partner in Deloitte has been found liable for violating conflict of interest rules for trading in stock and options of companies that were also firm clients.
Thomas Flanagan was a 30-year veteran and a senior partner in the Big Four firm’s Chicago office. Delaware Court of Chancery Judge John Noble found on December 29 that Flanagan’s improper trading activity included clients Walgreen Co., Motorola Corp. and Allstate Corp., and that he concealed his actions from Deloitte. The firm wants Flanagan to pay monetary damages. A separate hearing will determine the penalty, which may include forfeiture of his retirement benefits.
Auditor independence is strictly required by accounting standards. Rules to prevent trading abuses are in place because accounting firm employees can learn private information that could affect stock prices. The case opened Deloitte up for scrutiny, and some companies conducted their own investigations into whether Flanagan’s involvement in their audits impaired Deloitte’s independence. Walgreens, Allstate and USG Corp. concluded independence was not impaired because Flanagan was not directly involved in their audits, the Chicago Tribune reported.
Reuters reported that Noble wrote that Flanagan “obviously” had been violating independence rules. The opinion also references “the magnitude of unauthorized trades,” and “the incredibly prescient trading in those clients for which Flanagan had material nonpublic information.” Noble wrote, “Instead of presenting facts that would undercut this inference or offer innocent explanations for his conduct, Flanagan has chosen to exercise his Fifth Amendment right against self-incrimination.”
Deloitte had filed suit in 2008, contending that Flanagan made investments in audit clients more than 300 times between 2004 and 2008. The judge cited one particular case in which Flanagan attended a meeting of Allstate’s audit committee where a draft of the company’s second-quarter earnings statement was handed out. The next day, July 18, 2006, Flanagan purchased call options in Allstate stock, then sold them on July 20, one day after Allstate’s earnings became public and the stock price went up. The gain was 85 percent.
Noble found that Deloitte was unaware of Flanagan’s activities until it was contacted by SEC investigators in 2008. Flanagan quickly resigned when confronted about the SEC probe.
"Because an auditor sells, at base, its independence, and integrity, the firm relies heavily on the purported honesty and independence of its professionals,” Noble wrote.