Madoff’s Accountant and the Financial Debacle

Madoff’s Accountant and the Financial Debacle
When Bernard Madoff’s Ponzi scheme was disclosed the world had questions with respect to his auditor. Where was Madoff’s Auditor? asked Financial Week.

The Securities and Exchange Commission, SEC, charged Madoff’s auditor with fraud.

The SEC's complaint alleges that Friehling enabled Madoff's Ponzi scheme by falsely stating, in annual audit reports, that F&H audited BMIS financial statements pursuant to Generally Accepted Auditing Standards (GAAS), including the requirements to maintain auditor independence and perform audit procedures regarding custody of securities.

F&H also made representations that BMIS financial statements were presented in conformity with Generally Accepted Accounting Principles (GAAP) and that Friehling reviewed internal controls at BMIS, including controls over the custody of assets, and found no material inadequacies. According to the SEC's complaint, Friehling knew that BMIS regularly distributed the annual audit reports to Madoff customers and that the reports were filed with the SEC and other regulators.

The SEC's complaint alleges that all of these statements were materially false because Friehling and F&H did not perform a meaningful audit of BMIS, and did not perform procedures to confirm that the securities BMIS purportedly held on behalf of its customers even existed.

Instead, the SEC alleges that Friehling merely pretended to conduct minimal audit procedures of certain accounts to make it seem like he was conducting an audit, and then failed to document his purported findings and conclusions as required under GAAS. If properly stated, those financial statements, along with BMIS related disclosures regarding reserve requirements, would have shown that BMIS owed tens of billions of dollars in additional liabilities to its customers and was therefore insolvent.

According to the SEC's complaint, Friehling similarly did not conduct any audit procedures with respect to BMIS internal controls, and had no basis to represent that BMIS had no material inadequacies. Afraid that his work for BMIS would be subject to peer review, as required of accountants who conduct audits, Friehling lied to the American Institute of Certified Public Accountants for years and denied that he conducted any audit work.

The SEC further alleges that Friehling and F&H obtained ill-gotten gains through compensation from Madoff and BMIS, and also from withdrawing returns from accounts held at BMIS in the name of Friehling and his family members.
The SEC's complaint specifically alleges that Friehling and F&H violated Section 17(a) of the Securities Act, violated and aided and abetted violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and aided and abetted violations of Sections 206(1) and 206(2) of the Advisers Act, Section 15(c) of the Exchange Act and Rule 10b-3 thereunder, and Section 17 of the Exchange Act and Rule 17a-5 thereunder. Among other things, the SEC's complaint seeks financial penalties and a court order requiring both Friehling and F&H to disgorge their ill-gotten gains.

Avoiding Peer-Reviews

The Complain filed in the District Court of Southern District of New York, account no. 5 states: “In addition to the conduct alleged above, Friehling falsely represented to the American Institute ofCertified Public Accountants ("AICPA") that he was not engaged in audit work. By doing so, Friehling avoided the AICPA's peer review requirements applicable to auditors, which might have exposed that his so-called audit work for BMIS was a sham and might have exposed BMIS to greater scrutiny. Friehling also furthered the fraud by authorizing BMIS to send account confirmation documents to its customers falsely identifying F&H as BMIS' independent accountant, and representing that F&H conducted audits ofBMIS. Moreover, Friehling purported to perform agreed-upon procedures on the accounts of specific BMIS customers who had requested that he do so. In fact, Friehling did not subject these accounts to such procedures, but he nevertheless represented to these customers and their auditors that he had performed the procedures and found no problems. All of these actions were designed to, and did, shield BMIS and Madoff from any real scrutiny by regulators, customers" and qualified auditors.”

Principles of Professional Conduct

The Principles of Professional Conduct, Article I, Responsibilities states: “As professional, certified public accountants perform an essential role in society. Consistent with that role, members of the American Institute of Certified Public Accountants have responsibilities to all those who use their professional services. Members also have a continuing responsibility to cooperate with each other to improve the art of accounting, maintain the public’s confidence, and carry out the profession’s special responsibilities for self-governance. The collective efforts of all members are required to maintain and enhance the traditions of the profession.”
Had this firm followed the established procedures, more likely than not, this financial debacle has been prevented. Now many forensic accountants will be gathering information and preparing schedules that will help a judge to reach a just verdict in this case.
Our commitment is keep our responsibilities in carrying out professional engagements. We must exercise sensitive professional and moral judgments in all our activities.

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