If It’s Not One Thing, It’s Another – Auditors Getting Sued Over MadoffBy Francine • Dec 18th, 2008 • Category: BDO, EY, KPMG, Madoff, PricewaterhouseCoopers, SEC, The Case Against The Auditors
The “victims” of the Bernie Madoff scandal are not taking their losses laying down. Why are so many suits suddenly being brought against the auditors of the funds that invested on behalf of their clients in the Madoff funds?
“A friend recalled this scene from decades ago: The president of a small Orthodox synagogue in New York had apparently absconded with about $2 million from the congregation, a huge sum in those days. But since he had not yet been formally charged or arrested, he was free to attend Shabbat services. Which he did.
Seeing the alleged scoundrel, another man — a Holocaust survivor — rose and faced his fellow congregants, banged on the bimah table and demanded a judgment from the rabbi before the Torah portion was chanted. “In America, if you are willing to work hard, you can earn a living,” the man said angrily. “You don’t have to steal!”
…there is a gnawing temptation to subject Bernard Madoff to such a ceremony, to publicly point the finger on behalf of the family members, friends, rabbis, business partners, communal leaders and untold numbers of ordinary folk whose lives and good causes have been permanently disrupted by his audacious, unfathomable deceit and say: You didn’t have to steal! You didn’t have to steal from us, your people!…”
What’s worse is that those who should be the guardians of the public trust and watchdogs for those who can not watch for themselves were, in the words of one source today, “…either complicit, incompetent or duped.” None of these conclusions is very appetizing.
From the Jewish Daily Forward again:
“…Any doubt that the proper regulatory function of the federal government was stripped bare and impotent during the Bush administration should now be laid to rest. Even the chairman of the Securities Exchange Commission had to acknowledge that his agency was shamefully asleep at the wheel. Congress, too, must work swiftly to undo the mess it helped create on its sprint to deregulate too many sectors of the economy that clearly cannot be left to guard their own hen houses.”
Within the last forty eight hours or so, at least four lawsuits have been brought against audit firms by clients of so called “feeder funds” that invested in Madoff funds.
From The Financial Times:
Top accounting firms were hoodwinked by Bernard Madoff’s alleged $50bn fraud as well as several leading banks and some of the world’s biggest hedge fund investors, according to lists of service providers to Madoff-linked funds.
PwC, KPMG and Ernst & Young, three of the “big four” accountants, and an arm of BDO International, the fifth largest, were all auditors of the feeder funds which channelled money into accounts at Mr Madoff’s New York brokerage.
The New York Law School became the first Madoff victim to target an accountant this week when it named BDO Seidman in a lawsuit alongside Ezra Merkin and his Ascot Partners fund, which invested almost all its money with Madoff and was audited by BDO.
PwC was auditor of Fairfield Sentry, the $7.3bn feeder fund run by New York-based Fairfield Greenwich; of Kingate Global, a $2.75bn feeder fund run by London’s FIM Advisors; and of Gibraltar-based Reliance Management’s $488m Defender fund.
KPMG audited two of Tremont Group’s Rye Select funds, which had $2.37bn invested with Mr Madoff. Other Tremont funds also invested with Mr Madoff, giving clients of the the New York-based manager a total exposure of $3.3bn, according to people familiar with the situation.
Ernst & Young audited at least four feeder funds. Two of them with $2.5bn are from Herald Asset Management, linked to Vienna’s Bank Medici, which is part-owned by Unicredit of Italy. The other two funds with $870m are managed by Pioneer Alternative Investments, a Unicredit subsidiary.
Fairfield itself is now considering suing PwC…”
Separately, in a second lawsuit, Scott Berrie, an investor in Gabriel Partners, another investment partnership managed by Merkin, is suing Gabriel and BDO Seidman, the auditor, for alleged securities fraud and negligence.
And from Business Week:
“…more than 100 people who have contacted a Long Island (N.Y.) law firm that has filed a class-action suit against Madoff’s investment company…
So far, the list includes Carl Shapiro, a 95-year-old former garment industry executive who reportedly had $400 million of his personal wealth invested with Madoff, as well as $145 million from his family foundation; Irwin Kellner, chief economist for MarketWatch and the lead plaintiff in the class action, who invested more than $2 million; and Lawrence Velvel, 69, dean of the Massachusetts School of Law, who told the Associated Press he and a friend may have lost millions of dollars between them in bad Madoff investments.”
Yesterday, Stephen Grendel of Time Inc.com asked the question, “How Culpable Were The Auditors?”
I spoke to him on Thursday and he told me that the lawsuits so far primarily focus on investors in feeder funds that put substantially all or a very large percentage of their assets in Madoff’s funds. Whereas you may not expect an auditor to verify existence or valuation of underlying assets of a fund that was a non-material asset on another fund’s balance sheet, if Madoff’s funds were the whole balance sheet, the entire portfolio of a foundation of a feeder fund, you would expect their auditors would kick the tires harder, go check out the operation, look for the assets and verify the balances in person. This is especially true given the fact that Madoff’s operation was performing all of the roles – investment advisor, brokerage, trade clearing and asset custodian. This is highly unusual.
And so is the fact that a fund of this size would be audited by a three person firm that no one else had ever heard of.
Despite these obvious warning signs, ones that were enough to turn a few others off, including Société Générale who blacklisted Madoff’s funds, the Center for Audit Quality, the audit industry lobbying group, says the auditors did everything they are supposed to do.
Cindy Fornelli, executive director of the Center for Audit Quality, which is a Washington-based public-policy organization that represents public-company auditors, contends that all the Madoff case amounts to is a lack of sufficient regulation, not a failure of the accounting profession. “It is not the responsibility of the accountant for a capital-management firm to audit the underlying investments of the firms it invests in,” says Fornelli. “The auditor is not in a position to test the existence of the underlying securities — especially in a fund-of-funds situation.”
Looks like some are already setting up the auditors to use the “I was duped” defense. Probably not a bad idea since being judged complicit or incompetent is not very appealing
And now we find that the hinky-dink firm that was Madoff’s auditor has never submitted to a peer review, even though it is enrolled in the AICPA’s program and it’s only active accountant is a past president of his county’s chapter of the New York State Society of CPAs.
Friehling & Horowitz, is now also being investigated by the American Institute of Certified Public Accountants, the prestigious body that sets U.S. auditing standards for private companies.
The problem: The auditing firm has been telling the AICPA for 15 years that it doesn’t conduct audits. Friehling & Horowitz is enrolled in the [peer review] program but hasn’t submitted to a review since 1993, says AICPA spokesman Bill Roberts. That’s because the firm has been informing the AICPA — every year, in writing — for 15 years that it doesn’t perform audits…
Meanwhile, Friehling & Horowitz has reportedly done just that for Madoff. For example, the firm’s name and signature appears on the “statement of financial condition” for Madoff Securities dated Oct. 31, 2006. “The plain fact is that this group hasn’t submitted for peer review and appears to have done an audit,” Roberts says. AICPA has now launched an “ethics investigation,” he says.
The latest news from The Financial Times, just when you thought it could not get any worse, any uglier…
“Leading banks from Britain, France and Japan helped investors treble or quadruple bets on Bernard Madoff by lending billions of dollars to “feeder” funds, which placed their money with the alleged fraudster.
HSBC, Royal Bank of Scotland, Nomura and BNP Paribas lent the money without spotting a fraud, and in at least one case without due diligence teams visiting Mr Madoff’s brokerage, which held the assets. Banks including Nomura and Spain’s BBVA also helped create special “notes”, structured products that allowed small investors or those barred from investing in offshore vehicles to put as little as $50,000 into Madoff feeder funds….
Bankers said they had done everything they could, including checking the auditor and regulatory reports, and could not have been expected to spot a fraud.
“The lending bank clearly looks at all the data available, looks at the audited material, what the regulators have said, does a site visit to the fund of funds [feeder fund]: they go through everything,” said one bank facing a big potential loss…”