An SEC enforcement action alleges that the outside auditors of Bernard Madoff Investment Securities LLC committed securities fraud by representing that they had conducted legitimate audits, when in fact they had not. The SEC had previously charged the Madoff firm with committing securities fraud through a multi-billion dollar Ponzi scheme perpetrated on advisory and brokerage customers. The SEC complaint alleged that the audit firm obtained ill-gotten gains through compensation from the investment firm, and also from withdrawing returns from accounts held at the Madoff firm in the name of the audit firm’s sole shareholder and his family members. Among other things, the SEC seeks financial penalties and a court order requiring both the auditor and the audit firm to disgorge their ill-gotten gains. (SEC v. Friehling & Horowitz, CPAs, PC, SD NY)
The auditor’s alleged fraud was egregious, said James Clarkson, Acting Director of the SEC’s New York Regional Office, adding that the audit firm essentially sold its license to Madoff for more than 17 years while the Ponzi scheme went undetected. For all those years, the auditor deceived investors and regulators by declaring that the enterprise had a clean audit record.
The audit firm’s failure to conduct essentially any audit testing, said the SEC, left the Madoff firm’s purported transactions, balances and financial statements completely unexamined. Even more critically, the outside auditor did not attempt to confirm that the securities the Madoff firm purportedly held on behalf of its customers even existed, alleged the SEC, which is a standard and fundamental procedure for broker-dealer audits.
The SEC alleged that the auditors enabled Madoff’s Ponzi scheme by falsely stating, in annual audit reports, that they audited the firm’s financial statements pursuant to Generally Accepted Auditing Standards (GAAS), including the requirements to maintain auditor independence and perform audit procedures regarding custody of securities.
The audit firm also represented that the financial statements were presented in conformity with US GAAP and that the investment firm’s internal controls, including controls over the custody of assets, were adequate. According to the SEC, the outside auditor knew that the firm regularly distributed the annual audit reports to Madoff’s customers and that the reports were filed with the SEC and other regulators.
The SEC alleged that all of these statements were materially false because the audit firm did not perform a meaningful audit and did not perform procedures to confirm that the securities the Madoff firm purportedly held on behalf of its customers even existed.
Instead, alleged the SEC, the auditors merely pretended to conduct minimal audit procedures of certain accounts to make it seem like they were conducting an audit, and then failed to document their purported findings and conclusions as required under GAAS. If properly stated, continued the Commission, those financial statements, along with the firm’s related disclosures regarding reserve requirements, would have shown that the investment firm owed tens of billions of dollars in additional liabilities to its customers and was therefore insolvent.