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Running Head: " BERNARD L.

MADOFF INVESTMENT AND SECURITIES: A FOCUS ON
AUDITOR'S LEGAL LIABILITY AND DUE CARE"

"Bernard L. Madoff Investment and Securities: A Focus on Auditor's Legal Liability and Due
Care"
XNAMEXXX
New England College

MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S LEGAL LIABILITY AND DUE CARE" Abstract Friehling & Horowitz were the auditing firm that "audited" Bernard Bernard L. Madoff Investment and Securities (BLMIS) for over 15 years. sold and maintained proper custody of investment Securities? (3) Are there any mitigating factors to help defend the actions of the auditors? and (4) Should the BLMIS auditor Friehling face criminal charges? Based on case information. reviewed to determine whether BLMIS had purchased. fraud. The following 4 questions will be addressed (1) Did Friehling & Horowitz exercise due care and maintained professional skepticism during any of the Audits? (2) What audit evidence should have been vouched . while Bernie Madoff ran a Ponzi scheme under their noses."BERNARD L. I concluded that that the auditor David Friehling was indeed liable for fraud with very little mitigating factors. This paper addresses the legal liability of Friehling & Horowitz and their lack of due care. Keywords: Professional due care. BLMIS 2 . Madoff. that resulted in billions of dollars being stolen from investors.

(American Institutes of CPA's."BERNARD L. AICPA. objectivity. U. Friehling failed to conduct meaningful audits that complied with GAAS and GAAP and failed to conduct any audit procedures as to the internal controls of BLMIS and therefore has no basis to state that the BLMIS financials was free of material misstatements and inadequacies. Friehling & Horowitz did not exercise due care or maintained professional skepticism during any of the Audits that they signed off on for Bernard L. "SEC charges Madoff Auditors with fraud". disclose to the client any commission or referral fees.org/interestareas/personalfinancialplanning/resources/practicecenter/professionalresponsibilities/pages/professi onalresponsibilities. retrieved June 8. March 18. all AICPA members are required to follow a rigorous Code of Professional Conduct which requires that they act with integrity. Additionally. Securities and Exchange Commission (SEC) . fully disclose any conflicts of interest (and obtain client consent if a conflict exists).gov/litigation/litreleases/2009/lr20959. 1. According to the SEC complaint filed in 2009². and serve the public interest when providing financial services. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S LEGAL LIABILITY AND DUE CARE" 3 Question 1: Friehling & Horowitz . 2014 from http://www." ¹ Based on the available case information. competence. due care.sec. 2014) on their website under Professional Responsibilities state " CPAs are licensed and regulated by their state boards of accountancy.htm . 2014.aspx 2.aicpa. 2009 retrieved June 08.S.Due care and professional skepticism The AICPA. "AICPA Professional Responsibilities". maintain client confidentiality. Madoff Investment and Securities (BLMIS). Friehling also failed to maintain auditor independence as he clearly indicated later on that he knowingly left a signature stamp and the accounting firm's stationery at BLMIS and he did knot know when and for what purposes these were used. 2014 from http://www.

but only pretended to conduct minimal audit procedures of some accounts to make it appear that he has conducted an audit. I did not object and I agreed to it.com/marketbeat/2008/12/16/madoffs-not-so-unique-options-strategy/ . revenues. Furthermore. Friehling failed to conduct independent verifications of the BLMIS assets.com/2009/03/18/sec-charges-madoff-auditors-with-securities-fraudpretending-to-perform-audit/ 5. They failed to fulfill the requirements of the Responsibility Principal under GAAS. Erik. Erik 2013). He never reviewed material sources or tested and verified the existence and validity of any of these transactions nor did he send independent confirmations to the bank through which billions of his clients' money flowed. or performed due care as they failed to gather any material evidence. nor did they objectively evaluate the evidence. Gaffen. The SEC in their complaint (SEC. "SEC Charges Madoff Auditors With Securities Fraud. "Madoff’s Not-So-Unique Options Strategy" December 16. thus they were unable to render an opinion.html 4.wsj. "Madoff Ex-Accountant Tells Jury Aide Helped Fudge Taxes" November 13. securities purchased and sold as well as the custody of these securities.securitiesdocket. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S LEGAL LIABILITY AND DUE CARE" 4 Bloomberg's Erik Larson reported in 2003 that Friehling stated “It could be used to put my signature on any document at any time. 2008.2014 from http://www.³ (Larson.2009 Retrieved June 08.4 Professional skepticism was lacking as the auditors should have been skeptical of the bank transactions and the "extraordinary results" of Madoff's split-strike conversion strategy that continuously produced good returns even in a bad market. David 2008) 5 Therefore. “Pretending” to Perform Audit". commissions. liabilities related to client accounts and the bank account with Chase Manhattan NY (SEC 2009)².Larson.2013 . 3. retrieved June 08. Retrieved June 08. 2009)² alleged that Friehling did not conduct an Audit.(Gaffen.2014 from http://www.bloomberg.com/news/2013-11-12/madoff-ex-accountant-tells-juryaide-helped-fudged-taxes. 2014 from http://blogs. (SEC 2009)² At no point did Friehling test the BLMIS internal controls to determine if there was any and if these controls were sufficient to prevent fraud. March 18."BERNARD L. David. Securities Docket. Bloomberg. Friehling & Horowitz did not maintain professional skepticism. without my knowledge. Wall Street Journal.

pdf . Relevance refers to audit evidence relating to the assertion made on the financial statements." 6 (AICPA. December 15. December 2006." 6 (AICPA December 2006. "Audit Evidence AU Section 326" paragraph 04). MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S LEGAL LIABILITY AND DUE CARE" 5 Question 2: Required Audit Evidence for BLMS Audit According to AU Section 326 from the AICPA website (AICPA. in the case of BLMIS. The quality of audit evidence gathered. the auditor should obtain other audit evidence. "However. that is being tested and will allow the auditor to reach an conclusion. "Audit Evidence AU Section 326" paragraph 02).org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00326. Trusted external confirmations are considered more reliable. is measured by the relevance and the reliability of the evidence. 6."BERNARD L. December 2006. "Audit Evidence AU Section 326" paragraph 01 ) 6 "The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit. Reliability refers to whether the evidence can be trusted and relied upon as an true certification/ indication in the financial statement assertion being tested.aicpa. The type and the quantity of documentation and evidence would be subject to the professional judgment of the auditor. the audit of just one (1) transaction would have brought to light that no investment securities were ever traded. AICPA."AU Section 326 Audit Evidence". 2006 Retrieved June 08.2014 from http://www. The greater the possibility of a misstatement the more evidence will be required. "Audit Evidence AU Section 326" paragraph 08) Evidence must be relevant and valid to the entry that is being audited. while the AICPA does not require an auditor to audit every transaction 6 (AICPA December 2006." and in paragraph 8 indentation 1 "Audit evidence is more reliable when it is obtained from knowledgeable independent sources outside the entity. because accounting records alone do not provide sufficient appropriate audit evidence on which to base an audit opinion on the financial statements.

AICPA. and confirming the number of shares with the issuer or custodian. 2006 Retrieved June 08. checks issued or wire transfers. similarly would include invoices issued. Gross negligence is the performing of duties without proper care that it results in others being misled.aicpa. Evidence would include. but not be limited to."BERNARD L. cash received in the bank account. inspecting the securities. Fraud is the deliberate misrepresentation of a fact that the person/auditor knows to be false and is done with the intend to defraud.pdf . 6. ordinary negligence. an independent confirmation letter should be send to the financial institution or issuer that serves as the custodian for the investment security.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00326. Question 3: Auditors Common Law Liability to Third Parties. purchase orders and confirmations. (AICPA December 2006). statements and reconciliation and confirming the number of shares with the issuer or custodian. bills received(invoices). December 15. an competent auditor would vouch external documentation when auditing investment securities purchased.2014 from http://www. In order to confirm the proper custody of investment securities. Evidence for investment securities sold."AU Section 326 Audit Evidence". while auditing. gross negligence and fraud. There are 3 levels liability that arises out of failure to exercise the appropriate level of professional due care. Ordinary negligence is the failure to perform duties with reasonable due care resulting in an unintentional misrepresentation. reading the agreements and investment contracts. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S LEGAL LIABILITY AND DUE CARE" 6 Thus in order to comply with paragraph 04 of Section 326.

In addition. 2014 from http://www.gov/news/press/2009/2009-60. 2008) The SEC maintained that if an proper audit was done. The BLMIS auditors. U. Securities and Exchange Commission (SEC). Alyssa . as required. "SEC charges Madoff Auditors with fraud".com/2008/12/17/news/companies/madoff. March 18.. 7 (SEC. 2014 from http://www. Friehling & Horowitz. 3rd parties have a solid case. Retrieved June 8. failed to conduct an audit. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S LEGAL LIABILITY AND DUE CARE" 7 The difference between the fraud and gross or ordinary negligence is that with fraud there is knowledge that the representation is false where as with gross and ordinary negligence there are no prior knowledge of the misstatement. 2009 retrieved June 08.htm . "SEC charges Madoff Auditors with fraud". 2009 retrieved June 08.cnn. that he did not do any audit work. According to the SEC complaint. "Madoff's auditor.S. March 18. Friehling pretended to do an audit by producing minimal audit procedures to specified accounts.htm 8. Alyssa. he lied to the AICPA and insisted in writing for at least 15 years.fortune/ 9. Securities and Exchange Commission (SEC) .. doesn't audit?"."BERNARD L.sec. CNN Money. CNN Money.auditor. 2008. U. 2014 from http://money. 2009)."9 7. 8 (Abkowitz . then the Audit would have shown that BLMIS owed " tens of billions of dollars in additional liabilities to its customers and was therefore insolvent.S. Since the investors relied on these financial statements that were materially misstated and incurred economic losses based on the material misstatements.gov/litigation/litreleases/2009/lr20959.sec.Abkowitz . Under common or statutory law auditors will be liable to all 3rd party users of the financial statements. December 19. being concerned that his work for BLMIS would be subject to a review by his peers.

businessinsider.2009 retrieved June 08. March 18. while his sentencing hearing remains postponed. This fact and his recent cooperation with the authorities might possibly be the only mitigating factors that could count towards a reduction in his sentence. or any person who willfully. Friehling maintains to this day that he had no idea the Bernard Madoff was involved in a Ponzi scheme. David Friehling pleaded guilty on November 3. in a registration statement filed under this title. false fillings with the SEC and the fact that Friehling knew Madoff was handing these audited financial statements to potential investors. John.2014 from http://www. He has been cooperating with the authorities and that allowed him to remain free on bail."BERNARD L. Business Insider "SEC Charges Madoff Auditor With Fraud Too". MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S LEGAL LIABILITY AND DUE CARE" 8 Based on the fact that no audits were performed. investment adviser fraud and obstructing tax law administration. 2009 to charges of securities fraud. his actions constituted a deliberate intent to defraud. makes any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make 10. he lost several million of his own and his children's money in this scheme. 2009). John.. Question 4: Should Friehling be facing criminal charges? Section 24 of the securities act allows for an auditor to be subject to criminal penalties and states: "Any person who willfully violates any of the provisions of this title. Friehling is definitely guilty of fraud. or the rules and regulations promulgated by the Commission under authority thereof. Carney.com/sec-charges-madoff-auditor-with-fraud-too-2009-3 .10 ( Carney.

states that to be subject to criminal charges the auditor must have "willingly and knowingly" been aware of the misstatement in the produced financial statements.gov/regulations/laws/rules/8000-6240. then the auditor should not be held liable as he performed the audit in accordance of the AICPA principals. or both. If the auditor performed with appropriate level of professional care and skepticism and the fraud goes undetected because of management interference or the sophistication of the fraud scheme. Related Acts. and prevent over zealous charging of auditors for the smallest infraction. Should the auditor fail to use due care and professional skepticism.Miscellaneous Statutes and Regulations" Section 24. Regulations. 8000 . Retrieved June 08. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S LEGAL LIABILITY AND DUE CARE" 9 the statements therein not misleading.000 or imprisoned not more than five years."BERNARD L. the auditor must have "willfully" issued financial statements with a material misstatement and filed these statements.) Section 32 of the Securities Exchange Act of 1934. Regulations. 11.FDIC."11 (FDIC Law.html . "FDIC Law. This is not always easy to prove but in the case of the BLMIS auditor. Friehling is was easy to prove as he filed statements showing huge profits and stability while BLMIS was in fact insolvent and owed billions in liabilities. shall upon conviction be fined not more than $10. accurate and without material misstatements.fdic. each case of potential fraud must be evaluated based on the circumstances of the case. Related Acts. then the auditor should be held accountable together with the management. To remain fair and impartial.2014 from http://www. 8000 Miscellaneous Statutes and Regulations. An auditing firm is engaged to perform an audit to establish that the financial statements are true. In order to be subject to criminal action.

the belief is that he did this to avoid detection if subjected to peer review. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S 10 LEGAL LIABILITY AND DUE CARE" However in the case of Friehling where there was a blatant disregard for the AICPA principals and no proper audit was ever performed. If Friehling performed just one audit during all the years he was the Auditor for BLMIS he could have detected the fraud and saved many investors from losing their life savings. The NY state and SEC was correct in charging Friehling with fraud."BERNARD L. in fact Friehling lied and intentionally told the AICPA in writing that he did not perform any audits. There is no excuse for Friehling not performing the duties he was "hired" for. .

cnn.businessinsider. & Brizee.com/2008/12/17/news/companies/madoff. Alyssa .. Moore. 2008.fortune/ Angeli.com/sec-charges-madoff-auditorwith-fraud-too-2009-3 . Soderlund. 2014 from http://www. Lawrick. J. 2006 Retrieved June 08.aicpa. December 15.auditor..english.edu/owl/resource/560/01/ Accounting Web.aicpa.pdf Carney. L. Retrieved June 8."AICPA Professional Responsibilities".. doesn't audit?". John..2014 from http://www..2014 from http://www. 2014. 2014 from http://www.2014 from http://owl. E.aspx AICPA. A."BERNARD L. Retrieved June 08. Anderson.org/research/standards/codeofconduct/pages/default. 2014. M. December 19. AU Section 326 Audit Evidence.aicpa.. 2014 from http://www.2009 retrieved June 08. 2009 Retrieved June 08.aspx AICPA..purdue. CNN Money.. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S 11 LEGAL LIABILITY AND DUE CARE" References Abkowitz .org/Research/Standards/AuditAttest/DownloadableDocuments/AU00326. (2010. Wagner. K. "Madoff’s accountant: When is an auditor not an auditor?" March 30..com/topic/watchdog/madoff-saccountant-when-auditor-not-auditor AICPA. E. 2014 from http://money. Retrieved June 8.accountingweb. March 18. retrieved June 8. Business Insider "SEC Charges Madoff Auditor With Fraud Too".org/interestareas/personalfinancialplanning/resources/practicecenter/pro fessionalresponsibilities/pages/professionalresponsibilities. May 5). General format. "AICPA Code of Professional Conduct". "Madoff's auditor.

).2013 . New York Times.2014 from http://www. "Madoff Ex-Accountant Tells Jury Aide Helped Fudge Taxes" November 13. Freier.Miscellaneous Statutes and Regulations" Section 24. "SEC charges Madoff Auditors with fraud". Bloomberg.securitiesdocket. Related Acts..nytimes. Retrieved June 08. et al. Retrieved June 08. (2012). 8000 . Deborah. 2014 from .html Gaffen.html Larson. Regulations.fdic. 2014 from http://blogs.com/2009/11/04/business/04madoff. Erik.com/2009/03/18/sec-charges-madoff-auditors-withsecurities-fraud-pretending-to-perform-audit/ Thibodeau.7 Bernard L Madoff Investment and Securities: A Focus of Auditors' Legal Liabilities U. MP Auditing & Assurance Service (5th ed.2014 from http://www. Wall Street Journal. "Madoff’s Accountant Pleads Guilty in Scheme" November 3. David.com/marketbeat/2008/12/16/madoffs-not-so-unique-options-strategy/ Henriques. March 18. Module C pages 633-676. March 18. March 18. 2013 "Auditing and Accounting Cases: Investigating Issues of Fraud and Professional Ethics " Case 2. SEC Charges Madoff Auditors With Securities Fraud.html Louwers.gov/regulations/laws/rules/8000-6240. Jay. 2008. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S 12 LEGAL LIABILITY AND DUE CARE" FDIC.2009 Retrieved June 08. retrieved June 08. “Pretending” to Perform Audit. 2014 from http://www. Securities Docket."BERNARD L. 2009 .2009 Retrieved June 08. T. Diana B. "Madoff’s Not-So-Unique Options Strategy" December 16. "FDIC Law.wsj.bloomberg. Retrieved June 08.2014 from http://www.com/news/2013-11-12/madoff-ex-accountant-tells-jury-aidehelped-fudged-taxes.S. Securities and Exchange Commission (SEC).

sec.pdf http://www.gov/litigation/complaints/2009/comp20959.S. "SECURITIES EXCHANGE ACT OF 1934" (page 364 . Securities and Exchange Commission (SEC).sec.pdf .gov/news/press/2009/2009-60.sec.section 32 Penalties) Retrieved June 08.htm and http://www.gov/about/laws/sea34."BERNARD L.2014 from https://www.htm U. MADOFF INVESTMENT AND SECURITIES: A FOCUS ON AUDITOR'S 13 LEGAL LIABILITY AND DUE CARE" http://www.sec.gov/litigation/litreleases/2009/lr20959.