Are These Insider Trading Allegations Bad News for Herbalife?

trader staring at screensWhen Herbalife makes the news, usually the names of hedge fund titans William Ackman and Carl Icahn — who have taken large, opposing positions on the nutritional supplement company — follow closely behind. But not in this case; The Wall Street Journal reported Tuesday that the auditor of Herbalife (NYSE:HLF) and shoe-maker Skechers (NYSE:SKX) was hit with an insider trading allegation.

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Both Herbalife and Skechers have confirmed that KPMG has resigned as their auditor, following an admission by the accounting firm that it had been forced to fire a senior partner over alleged insider-trading tips. KPMG — one of the Big Four accounting firms — made the accusation public on Monday afternoon, stating that the unnamed partner had divulged inside information about its clients to an investor who made stock market trades based on the tips. The accounting firm also said that it had resigned as the outside auditor of two of its clients as result, but the company did not name which clients.

The firm said in its statement, seen by the publication, that it was informed of the allegations at the end of last week. The firm also maintained that the partner “violated the firm’s rigorous policies and protections,” describing the behavior as “rogue.”

Shares of Herbalife and Skechers were both temporarily halted early Tuesday morning — although they both have since resumed trading — until further updates were released. Herbalife shares were off by as much as 2.3 percent after the stock began trading, but activist investor Robert Chapman Jr. told the Journal that he was “very long [on Herbalife] and will double [his] position today if it falls materially, as even KPMG has stated there is no reason to believe any accounting/audit work is improper.”

In February, Herbalife reported a 12% increase in fourth-quarter earnings and lifted its profit outlook for this year. At the time, the company also acknowledged that the U.S. Securities and Exchange Commission had requested information regarding its business and financial operations, and the company said it complied with that request.

Given the recent controversy over the nature of Herbalife’s business — Ackman shorted the company with a $1 billion bet based on his belief that it runs a pyramid scheme — it would be natural for investors to fear that KPMG resigned because of something unsavory its accountants found in Herbalife’s financial statements. But the company said that KPMG would no longer act as its accountant solely because of the impairment of its independence caused by the former partner’s alleged unlawful activities.

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KPMG will be withdrawing its audit reports on Herbalife financial statements for the past three years and the reports on the effectiveness of the internal control over financial reporting for the same period, according to the Journal. Audit reports for Skechers for the fiscal years 2011 and 2012 will be withdrawn as well. Yet the firm said that it had no reason to believe the financial statements contained errors.

Skechers Chief Financial Officer David Weinberg told the publication that the KPMG partner was under federal investigation for his alleged insider trading activities.

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