The U.S. Securities and Exchange Commission last week charged a former Deloitte and Touche LLP partner and his son with insider trading in the securities of several of the firm's audit clients.
The SEC alleges that Thomas P. Flanagan of Chicago traded in the securities of Deloitte clients, often while serving as a liaison between those companies' management teams and Deloitte's audit engagement teams. In this role, Flanagan had access to advance earnings results and other nonpublic information from Deloitte's audit engagements with Best Buy, Sears, and Walgreens, as well as the firm's consulting engagement with Motorola. Flanagan made trades in the securities of these and other companies while in possession of the confidential information, and also tipped his son Patrick T. Flanagan, who then traded on the basis of the nonpublic information.
"Flanagan's insider trading violated one of the most fundamental rules of public accounting," said Robert Khuzami, director of the SEC's Division of Enforcement. "All audit firms should learn from this unfortunate episode and employ vigorous controls designed to ensure compliance with the SEC's auditor independence rules."
The Flanagans agreed to pay more than $1.1 million to settle the SEC's charges.
"Thomas Flanagan repeatedly betrayed his ethical responsibilities and his clients' trust by trading on confidential information to enrich himself and his family," said Merri Jo Gillette, director of the SEC's Chicago Regional Office.
According to the SEC's complaint, filed in the U.S. District Court in Chicago, Thomas Flanagan worked at Deloitte for 38 years and rose to the position of vice chairman of Clients and Markets. The SEC alleges that Flanagan committed insider trading on nine occasions between 2005 and 2008 by trading in the securities of multiple Deloitte clients and a company acquired by Deloitte client Walgreens. Flanagan was in possession of nonpublic information about those clients that he learned through his duties as a Deloitte partner, including such material market-moving events as earnings results, earnings guidance, and acquisitions. Flanagan's illegal trading resulted in profits of more than $430,000. On four occasions, Flanagan relayed the nonpublic information to his son, who traded based on that information for illegal profits of more than $57,000.
In addition to the court-filed complaint alleging illegal insider trading, the SEC also instituted administrative proceedings against Thomas Flanagan, finding that he violated the SEC's auditor independence rules on 71 occasions between 2003 and 2008 by trading in the securities of nine Deloitte audit clients. Accountants are not independent if they own or control securities in the clients that they audit.
The SEC's settled administrative order finds that while Thomas Flanagan owned or controlled client securities, Deloitte issued audit reports to the clients stating that the financial statements contained in the reports had been audited by an independent auditor. However, Deloitte was not independent due to Flanagan's ownership and control of the audit clients' securities. As a result, the SEC's administrative order finds that Thomas Flanagan caused and willfully aided and abetted Deloitte's violations of the SEC's auditor independence rules under Regulation S-X. Flanagan also caused and willfully aided and abetted the clients' violations of the reporting and proxy provisions of the Securities Exchange Act of 1934.
Thomas Flanagan concealed his trades in the securities of Deloitte's clients and circumvented Deloitte's independence controls, according to the SEC's complaint. He failed to report the prohibited trades to Deloitte, lied to Deloitte about his compliance with its independence policies, and provided false information to Deloitte's personal income tax preparers about the identity of the companies whose securities he traded.
As a result of their conduct, the SEC's complaint charged Thomas and Patrick Flanagan with violations of Sections 10(b) and 14(e) of the Exchange Act and Rules 10b-5 and 14e-3. The SEC's administrative action found that Thomas Flanagan caused and willfully aided and abetted Deloitte's violations of Rule 2-02(b)(1) of Regulation S-X, and caused and willfully aided and abetted the clients' violations of Sections 13(a) and 14(a) of the Exchange Act, and Rules 13a-1, 13a-13, and 14a-3 there under.
Without admitting or denying the SEC's allegations in the complaint and the findings in the administrative order, Thomas Flanagan consented to the entry of an order of permanent injunction, disgorgement with prejudgment interest of $557,158, a penalty of $493,884, and a denial of the privilege of appearing or practicing before the SEC as an accountant.
Without admitting or denying the SEC's allegations in the complaint, Patrick Flanagan consented to the entry of an order of permanent injunction, disgorgement with prejudgment interest of $65,614, and a penalty of $57,656.
James O'Keefe, Steven Klawans, and Kathryn Pyszka conducted the SEC's investigation in this matter. The SEC acknowledges the assistance of FINRA and the Options Regulatory Surveillance Authority in this investigation.