Deloitte Insider Case Sparked Client Doubts about Audits

The auditor accused a 30-year partner of using his internal client data for personal gain, prompting companies for a time to investigate on their o...
Sarah JohnsonNovember 10, 2008

An insider-trading lawsuit brought by Deloitte & Touche against a former partner and vice chairman, Thomas Flanagan, led some corporate clients to scramble for a time to find out whether their third-quarter statements might be impaired by the allegations.

In a case filed in Delaware Chancery Court in late October, the audit firm sued Thomas Flanagan, a 30-year veteran of the firm, accusing him of improperly trading in the securities of at least 12 companies that Flanagan had advised over the past three years, from Deloitte’s Chicago office.

The suit has gotten scant coverage in the national media. In any event, some Deloitte corporate clients were worried that that it might not be proper to put the auditor’s name on their latest round of audited financial statements.

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After Deloitte told the clients in September that one of its partners may have improperly traded in the clients’ stock, some of the clients questioned whether Deloitte’s status as their independent auditor might be up in the air, raising the possibility the firms would have to hurriedly find a new audit firm.

At least three of these client companies conducted their own investigations after paying outside lawyers to look into the matter. However, Walgreen Co., Allstate Corp., and USG Corp. have decided that the audit firm’s objectivity has not been impaired and have submitted their Deloitte-blessed financial reports on time. They concluded in their latest 10-Ks or 10-Qs that Flanagan, whom Deloitte refers to as an advisory partner, was not directly involved with their audits.

USG, for example, decided to keep Deloitte as its auditor after an “extensive investigation” into Flanagan’s involvement with its audits, the company said in its 10-Q filed in late October. The manufacturer hired outside counsel to conduct interviews with Deloitte employees, as well as USG’s audit committee members and finance department employees, including its CFO. USG concluded that Flanagan did not have “any substantive role or influenced any substantive portion of any audit or review of our financial statements.”

Deloitte acknowledged in its Delaware complaint that some of its clients will have to incur “substantial out-of-pocket costs” to investigate whether they can retain the auditor under current Securities and Exchange Commission auditor independence rules and that those clients may sue Deloitte to compensate for those legal fees.

Deloitte claims that Flanagan held and traded securities of his own clients for the past three years. The firm alleges he bought one of his client’s stock one week before it announced an acquisition of a public company. He is also accused of violating the firm’s independence and conflict-of-interest policies and hiding his personal securities holdings from Deloitte. In his role as an advisory partner, he attended the audit committee meetings of seven of the 12 clients affected.

The firm filed its lawsuit against Flanagan nearly two months after he “abruptly resigned” in early September. Because of his “wrongful actions, Deloitte has suffered and will continue to suffer substantial injury,” the firm wrote in its complaint, alleging breach of fiduciary duty, breach of contract, and fraud.

According to Deloitte, the firm became aware of Flanagan’s alleged activities in August after federal regulators inquired about some of his clients. Soon after the firm confronted him, Flanagan quit. Flanagan could not be reached to comment for this story.

“Deloitte unequivocally condemns the actions of this individual, which are unprecedented in our experience,” said Deloitte spokeswoman Deb Harrington in a statement to “His personal trading activities were in blatant violation of Deloitte’s strict and clearly stated policies for investments by partners and other professional personnel. Further, it appears that he intentionally skirted our system for reporting and tracking investments.”