ACG 6685 Florida Atlantic University Madoff Scandal Response REPLY TO The POST BELOW WITH INTELLIGENT THOUGHTOUT ANSWERS NOT JUST A SIMPLE YES OR NO, 2 PARAGRAPHS MINIMUM 3 MAX
Madoff story up to date
In my post, I would like to put the case dates in a sequence to have a better understanding of the Madoff scandal.
As the textbook and the readings elucidated that, on December 10, 2008, Bernie Madoff admitted to the world that the business he was running successfully was ‘all just one big lie’ and basically a giant Ponzi scheme estimated approximately $64.8 billion. Later he surrendered to the authorities, saying there is no “innocent explanation”. On March 12, 2009, Madoff was jailed after pleading guilty to 11 federal felony counts. June 29, 2009, Madoff was sentenced to 150 years in jail. Madoff, 82, is currently locked up in a federal prison in North Carolina. On February 5, 2020, Madoff, who is suffering with terminal kidney disease and have only a few months to live, asked the court for an early release from prison. But the court refused his request on June 4, 2020, saying that Madoff has never fully accepted responsibility for his actions. Earlier in July 2009, he asked President Trump to commute his 150 years sentence. Now he hopes President Trump would consider commuting the sentence.
Although Bernie Madoff claimed that he acted alone in his scam, his family and close associates were also players in the Ponzi scheme. On December 11, 2010, Mark Madoff, the older son of Bernie, committed suicide and on September 3, 2014, Andrew Madoff, the younger son of Bernie, died of cancer. Ruth Madoff, the wife of Bernie, was sued by trustee Irving Picard for $45 million. After long court proceedings, in May 2019, Ruth Madoff agreed to pay $594,000 and agreed to surrender her remaining assets when she dies. Peter Madoff, brother of Bernie, who worked with his brother for more than 40 years, was sentenced to 10 years prison in his involvement in the Ponzi scam and currently serving his sentence at FCI-Miami.
Madoff’s long-term auditor-David Friehling pleaded guilty in November 2009 to the nine-count indictment. In May 2015, he was sentenced to one year of home detention and one year of supervised release. He avoided prison because of his extensive cooperation with the authorities and he was unaware of the extent of Madoff scam. However, he was expelled from AICPA and his CPA license was revoked by the NY state board of accountancy.
Other updates after the case book printed
On February 1 2016, trustees announced that more than $11.079 billion of the $17.5 billion in principal investment has been recovered. On November 9, 2017, The US Department of Justice announced that it would begin distributing funds to Madoff victims from “Madoff Victim Fund”. To assist investors in recovering their lost funds, the US government established this fund in 2013. On April 20 2020, the Department of Justice announced the fifth distribution of $378 million to more than 26000 victims worldwide.
My thoughts on Madoff auditor
David Friehling, who was the sole practitioner at Friehling & Horowitz Accounting firm, performed the annual audits of Madoff and provided unqualified audit opinions on Madoff’s financials. He did not exercise due care and did not maintain professional skepticism throughout the audits. Professional skepticism will allow the auditor to ask the right questions to figure out the financial statements true or not. One thing the auditor must do is to test whether the internal controls are effective or not. David Friehling did not tested the internal controls at Madoff Securities. Another important problem was, Friehlin’s independence as the auditor of Madoff, was seriously impaired because he and his family had dozens of financial investments with Madoff that exceeded the allowed limits. These investments openly disregarded the independence rules and disqualified Friehling from serving as the auditor of Madoff Securities. Other serious issues related to audit documentation. There was no proper audit documentation evidence that, Friehling had verified Madoff’s assets and liabilities, reviewed Madoff’s revenues, examined bank accounts, and verified Madoff’s purchases and custody of securities. Friehling did not conduct the audits in accordance with GAAS. His job was simply rubber stamp the financial statements and he betrayed his fiduciary duty to investors and his legal obligation to regulators. For all the years of his audits, he was lying to the AICPA that he did not perform any audits to avoid the AICPA peer review program. His shameful role in the Madoff scandal is a great example of what happens if an auditor does not perform his duties truthfully and lacks due care while performing the duties.
Failure of oversight authorities -Why did it happen, and could it happen again?
The SEC- “Madoff Securities was audited by a one-man accounting firm”- this was one of the red flags out of the 29 red flags identified by Harry Markopolos in his lengthy report sent to the SEC in 2005. However, SEC failed to investigate vigorously and to charge Madoff with any serious infractions of the laws in all its investigations. The SEC did not understand the red flags and the length of the Ponzi scheme. It was criticized that the SEC’s accountants, attorneys and stock market specialists were not capable of understanding a derivative based Ponzi scheme. Another reason was Madoff’s great image as Wall Street icon which acted as a shield from regulatory oversight.
The AICPA & NY State- Friehling and his firm were members of the AICPA. He reported to the AICPA each year that he did not perform any audits. Because of this, he never underwent a single peer review as required, during the time he was auditing Madoff’s financial statements. Moreover, Friehling’s firm was also not required to have a periodic peer review at the state level. At that time NY state did not have a mandatory peer review requirement. Therefore, Friehling could avoid the AICPA and the state board oversight for review of audit quality.
The PCAOB – At that time, it did not have the authority to regulate or inspect auditors of non-public broker dealers. Therefore, PCAOB did not inspect Friehling & Horowitz Accounting firm.
FINRA – Another oversight authority FINRA (Financial Industry Regulatory Authority) had the authority to examine and discipline surety firms and brokers but not investment advisory firms. It missed the red flags when conducting yearly inspections of the brokerage operations of Madoff.
After Madoff admitted the biggest Ponzi scheme, the SEC took decisive and comprehensive steps to reduce the chances that such frauds would occur or undetected in the future. The SEC included certain amendments to section 17 of the Securities Exchange Act of 1934 that require nonpublic broker-dealers ‘financial statements to be certified by a firm registered with the PCAOB. Now the PCAOB has the full authority to inspect, examine and discipline the auditors of all broker dealers, not just public broker-dealers.
The New York state board also signed off significant accountancy reforms. From 2012, accountancy firms in NY state must undergo a peer review once in three years.
I believe that the reforms made by the regulatory authorities after Madoff securities fraud, would minimize these kinds of frauds in the future.
Madoff was a “service provider” to various companies (feeder firms) that outsourced investment activities to Madoff. The auditors of the feeder firms had a responsibility to check out the service provider’s auditor. The feeder firms (user organizations) can implement controls over data sent to and received from the service organization so that any errors or irregularities made by the service organization can be detected and corrected by the feeder firms (user organizations). In accordance with SAS 70 audit, every service organization must display the adequacy of system controls and safeguards when they host or process their customers’ data.
In the case of Madoff, the user organizations simply relied on Madoff to implement effective control over their data and its integrity. The auditors of these user organizations (feeder firms) had overlooked the fact that Madoff’s huge organization was serviced by a single partner accounting firm. Before using the service auditor’s (Friehling & Horowitz) reports, the user auditor should have inquired about the service auditors’ professional reputation which was not done. They relied on unqualified report issued by Friehling & Horowitz, ignoring the fact that systems controls may not be adequate for every user organization. If the user (feeder) organizations had adequately investigated Madoff Investments in accordance with SAS 70, the fraud could have been detected earlier.
References :
Michael C Kapp. 2017, Contemporary Auditing: 11th Edition
https://www.cnn.com/2013/03/11/us/bernard-madoff-fast-facts/index.html (Links to an external site.)
https://en.wikipedia.org/wiki/Madoff_investment_scandal (Links to an external site.)