Tuesday, November 3, 2009

Holding Accountants Accountable for Securities Fraud (and Silliness)

Bernie Madoff’s, accountant, David G. Friehling, admitted in federal court that he had permitted Madoff to conceal his securities fraud scheme from regulators for nearly 20 years by never actually auditing Madoff’s operation. Friehling merely accepted “whatever figures he was given and plug[ged] them into independent audit” reports. For Friehling’s candid disclosure in federal court he faces a potential statutory maximum prison term of 114 years for nine criminal charges. The criminal charges include: (1) one count of securities fraud, (2) one count of aiding or abetting investment-adviser fraud, (3) four counts of making false filings to the Securities & Exchange Commission and (4) three counts of obstructing administration of the federal tax laws.

The Bernie Madoff fraud is one of the largest Ponzi schemes in history, with thousands of victims and approximately $50 billion in estimated losses. However, Friehling insisted that he had no knowledge about Madoff’s Ponzi scheme. “He had simply trusted Mr. Madoff.” Friehling also contends that he himself also invested $500, 000 with Madoff, and he had not idea that Madoff was engaged in a fraud. Besides the three tax charges, Friehling pleaded guilty to one count each of securities fraud and investment adviser fraud and four counts of making false filings to the Securities and Exchange Commission.

Additionally, Assistant U.S. Attorney Lisa Baroni stated that from 1991 through 2008 Friehling prepared false tax returns for Madoff and “other” Madoff family members, but declined to say who those others are. The false tax returns included individual income tax returns and returns for estates and trusts.

Earlier this year, Madoff admitted to operating the Ponzi scheme under the legitimacy of his Wall Street brokerage business. Frank DiPascali Jr., Madoff’s principle assistant, pleaded guilty to creating the fictitious paper trail of office records and customer accounts that helped deceive investors for almost 20 years. Yet, Friehling who “audited” Madoff’s brokerage firm operations, one of the biggest wholesale market-makers on Wall Street, and prepared Madoff’s personal taxes had not idea that there was fraud afoot. Hmmmmm? This really all sounds rather silly.

Friehling, a certified public accountant, created false and fraudulent certified financial statements from 1991 to 2008. Friehling knew that he failed to conduct independent audits of Madoff’s brokerage operations for almost 20 years. Friehling also knew that he failed to follow generally accepted accounting principles by merely accepting the information given to him by Madoff at "face value" without confirming the information. Friehling further knew that Madoff investors were relying on his “independent certified audits” in the mix of information that investors rely upon in deciding whether to invest in a particular investment. Friehling’s “independent certified audits” were material information that investors, federal regulators and taxing authorities relied upon for the truth and accuracy. Friehling futher stated that “in what is surely the biggest mistake of my life, I placed my trust in Bernard Madoff." In response to Mr. Friehling, I do not think that he made a mistake, I think he engaged in a crime for almost 20 years.

The Supreme Court, in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, (1976), articulated a legal standard for materiality. The Supreme Court held that the materiality element is met if there is "a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available." Additionally, SEC Staff Accounting Bulletin 99 - Materiality ("SAB 99") states that the FASB's Financial Accounting Concepts No. 2 defines materiality as “the omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.” When the Supreme Court’s materiality standard in TSC Industries, Inc. is juxtaposed against SAB 99, it is clear that Friehling’s failure to conduct any audit of Madoff’s investment firm and fraudulent filing of financial statement with the SEC for almost 20 years violated federal securities laws and is a crime. More importantly, it makes Friehling’s conduct given the legal and accounting standards under which he was required to conduct a full and complete audit of Madoff’s operations, almost silly. Silly in terms of the absolute absurdity of Friehling not even attempting to verify any of Madoff’s numbers given the enormity of Friehling’s duty under the federal securities regulation and accounting standards.

Therefore, it is not surprising that Friehling agreed to forfeit $3.18 million to the U.S. Attorney’s Office, as part of his criminal plea bargain and agreed to a partial settlement in the SEC's separate civil case. Friehling, further agreed to a permanent injunction restraining him or his accounting firm from violating securities laws. Friehling and his firm will be precluded from arguing that they didn't violate federal securities laws as alleged by the SEC for the purposes of determining disgorgement and any penalties. Friehling sentence is scheduled for late February 2010.


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  2. Wow. Where to start with this? First, regulatory authorities probed Madoff at least 8 times over 16 years, they received direct complaints about his operation, and still failed to uncover and stop his Ponzi scheme. Unbelievable.

    Should David Friehling and others who, either with knowledge or through incompetence, help promote and sustain Madoff's operation be prosecuted? Absolutely. But what about the regulators who are no less guilty? You say that Mr. Friehling faces, "a potential statutory maximum prison term of 114 years", tell me, what justice will Madoff's victims receive with regard to the regulators? These people had a fiduciary responsibility no less important than Friehling. Their salaries were being paid by the taxpayer. They had statutory authority to examine every aspect of Madoff's operation. Their guilt is undeniable.

    What's happened? Nothing. In fact, worse than nothing. Mary Schapiro, the Finra chief involved in several probes of Madoff's operation, was nominated by President-elect Barack Obama for the next SEC chairmanship. Pathetic.

    If you want any regulation to succeed, those that enforce the rules must be held accountable. It's time for an independent investigation of the regulators, if 114 years in prison is the penalty for Friehling, maybe a few years in prison is just for these criminally incompetent fools.

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